A continued weakness in the Indonesia rupiah could potentially damage the profitability of corporates as costs are expected to surge in the long-run.
Indonesia’s current account has remained in deficit for seven quarters and exports decreased for a fifteenth sucessive month in June, driven by declines in prices for the nation’s key commodity exports. As a result, it is Bank Indonesia’s (BI) policy to manage currency depreciation to support overseas shipments.
“The second quarter’s relatively wide current account deficit, slowing portfolio inflows and negative balance of trade means that the currency has to bear the brunt of achieving greater balance of payments equilibrium,” said Callum Henderson, Singapore-based head of foreign exchange (FX) at Standard Chartered (StanChart) to Asiamoney PLUS on August 21.
The central bank on August 16 announced a current account deficit of US$9.8 billion in the April-June period, equal to 4.4% of GDP, compared to the first quarter’s US$5.8 billion or 2.6% of GDP.
As a result, the rupiah fell to IDR10,500 per dollar for the first time since 2009 on August 19. The currency also has declined 5.4% this quarter and 9% year-to-date, the worst performance among Asia’s 11 most-traded currencies, according to Bloomberg data.
Indonesian corporates are mostly concerned about the longer-term repercussions of a weakening currency.
“In the short term we get the benefit of a currency weakness because we primarily deal in US dollars but in the long run, it gets planted into the cost factor, which will neutralise our benefits,” said a Jakarta-based chief financial officer (CFO) of a garment manufacturing company.
“With a weak currency, imported goods become more costly, resulting in the rise in overall inflation,” he added. “When that happens there will be a demand for higher wages and this will become a more permanent phenomenon.”
Wilianto Ie, Indonesia strategist at Nomura agrees: “The risk from a weak rupiah to corporates in Indonesia will arise from input cost pressure and thus margin contraction in our view. It will take time before corporates can pass on the cost increase to consumers.”
Bank of America-Merrill Lynch (BoA-Merrill) predicts that the rupiah could depreciate by another 3.6% toIDR11,300 per dollar by year-end.
Exporters vs importers
The weakened local currency has short-term implications for corporates, depending on whether the company is an exporter or importer. It is usually positive for the former and negative for the latter.
“Our inflows are in US dollars and 75% of our outflows are also in dollars,” said the CFO of the garment manufacturing company. “A small percentage of our outflows are in rupiah which mainly comprises of wages and other expenses. We are in a much better position as a result of the weakening currency because we don’t have any hedged forward positions.”
In fact, some bankers believe that the further weakening of the rupiah in the next several months would be a good opportunity for corporates to sell dollars.
“From a longer-term perspective – one to two year basis – exporters that are selling dollars and buying rupiah could sit back for now,” said StanChart’s Henderson. “But sometime over the next three to six months, they are going to have a golden opportunity to sell dollars at very attractive levels.”
On the other hand, importers are likely to struggle.
For example, a corporate that imports raw materials in foreign currency for production locally would find difficulties in managing a weaker rupiah. As a result, some have resorted to hedging their FX exposures in order to lock-in the long-term benefits.
“We do have a conservative policy on our foreign exchange. We do forward covers for our exposures, most of which would not be hedged for more than a quarter,” said a Jakarta-based CFO for a fast moving consumer goods (FMCG) company. “However, we might now consider lengthening the duration of our hedges.”
Despite these concerns, the currency risk to corporate balance sheets is not much, given the aggregate net debt to equity of top 50 corporates in Indonesia is only 22% as of the first half of 2013, notes Nomura.
“There is not much FX debt on listed corporates, and some of corporates that issued US dollar bonds without US dollar earnings, such as Astra’s subsidiaries, Federal International Finance and Astra Sedaya Finance, are required by Astra to swap or hedge their FX exposure immediately,” said Ie.
Working capital needs
In the past, it was the norm for Indonesian corporates to fund their local currency working capital requirements using US dollars. This was because the dollar’s interest rate was trading at a discount versus the local currency.
“Within a stable local currency environment, funding a local currency requirement using US dollars is typically a good deal. There is less of an FX risk associated,” said Andrew Ong, head of liquidity and investments at BoA-Merrill.
However, times have changed given that majority of emerging market local currencies have depreciated across the board against the US dollar in recent weeks. This has prompted some corporates to change their working capital funding strategies.
This is because BI is caught between the risk of a depreciating currency versus the risk of slowing GDP growth. It is trying to balance these out through higher interest rates which have risen 75bp in the past three months.
“From where we stand, some corporations have decided to revert back into local currency funding. They are becoming less dependent on US dollars for their local currency funding due to the currency volatility in Indonesia,” added Ong. “It’s also not helping that the rates of the local currency have also moved.”