Indonesia Bans Settlements in Foreign Currencies

Indonesia tomorrow – July 1 – will intensify its journey into economic isolationism when banking regulations go into effect banning the use of currencies other than the rupiah for settling domestic transactions.

As much as US$12 billion a day in such settlements between domestic parties, including multinationals doing business in Indonesia, are expected to be banned and must be transacted in rupiah, which is expected to cause turmoil for both domestic and international companies, unloading currency risk onto local companies as the rupiah continues to descend in value. Roughly 45 percent of Indonesian working capital and investment lending in the last year was in foreign currencies, according banking research reports, and now will have to be settled in rupiah.

Multinationals, particularly in the extractive industries such as crude production and mining, face disruptions as dollars are commonly used to buy and sell commodities and equipment on the international markets. The mining industry had already been hit with an earlier law that said all ore must be refined in the country, requiring the construction of domestic smelting plants although most mining is far from areas where there is enough energy to operate smelters.

A ban on export of minerals until the smelter issue could be solved resulted in an exports contraction for most of 2015, down 15 percent annually in May. Imports, a leading indicator of domestic demand, are falling even faster, down for the second month by more than 20 percent annually.

Nonetheless, although the rupiah has been the worst-performing currency in Asia for several months, Ronald Waas, the deputy governor of Bank Indonesia, told bankers on June 15 that “the regulation…is expected to promote strengthening and purifying payment transactions within the Republic of Indonesia by the use of rupiah.”

“In the beginning there may be one-off adjustments to prices and rates, but in the long run, it should make them more cost-efficient," Peter Jacobs, a director at the monetary authority, said in an e-mailed response to journalists last week. "There is a cost to mitigating foreign-currency risk, but this is good corporate governance and when hedging products become more common in Indonesia, the cost will fall."

The opposite appears to be happening. Indonesia is plagued by a current account deficit that for the first quarter reached 1.8 percent of gross domestic product – while it fell over the 2014 final quarter – is expected to widen again. The current account deficit has plagued the currency, Asia’s weakest, which has fallen to its lowest level since the 1997Asian Financial Crisis.

The country also faces the highest inflation in the Asean region at 7.40 percent annually, limiting the ability of the central bank to raise rates to combat the currency’s decline, which is now close to 13,500 to the US dollar, down from Rs11,500 as late last August.

While the currency law specifying rupiah settlements has been in effect since 2011, it was previously considered to apply to cash transactions only. While the 2011 law permits parties to contract out of the requirement to use rupiah by written agreement, that right now appears to have been closed by a Bank Indonesia ruling in March. And while foreign companies have been hopeful that payment transactions made by or to foreign-incorporated entities within Indonesia would be automatically exempt, “that is not the case,” according to the international law firm Jones Day.

Bank Indonesia is also expected to require companies to hedge at least 25 percent of their short-term external debt not offset by foreign-currency holdings, with sanctions coming into effect from October.

With an inexperienced president at the controls, nationalist voices from both within and outside government are contending that globalization is harmful to Indonesia’s interests and that the country, with 40 percent of the consumer market in the 10-member Association of Southeast Asian Nations, is big enough to call the shots to multinationals.

Accordingly, in addition to the currency regulation, Indonesia appears to be turning towards long-discredited policies of import substitution abandoned by most fast-growth economies decades ago. Accordingly, it has tightened the screws particularly on the extractive industries.

The government is also, for instance, poised to introduce regulations to require local content for smartphones – although Indonesia has virtually no top-drawer tech industry to supply the content. A pending data center regulation is designed to require all businesses including banks and social media giants like Facebook to keep all their data centers in-country. This again is moving forward despite a worrying lack of infrastructure, security concerns and the global movement of data to cloud providers. Work permits for expatriates are increasingly difficult to obtain despite a skilled labor shortage.

The regulation means that procurement expenses for local companies to local suppliers will rise by up to 1 percent and that local companies must now rely on loans denominated in rupiah, boosting the cost of funds by more than 5 percent. For service providers such as legal and accounting firms, among others, quoting in US dollars is a natural hedge against a weakening rupiah because they typically don't get paid for several months after doing the work

Listing real estate prices in dollars is also common, particularly for apartment rentals and offices, with some 30 percent of office rents in dollars, according to property brokers. With borrowing forced in rupiah without the ability to hedge in foreign currencies, given the volatile rupiah, developers could begin to back away from projects because of the uncertainty.