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Opposition to Indonesia's currency peg and RHB-BOC merger failure add to short-term weakness

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ECONOMICS & STRATEGY
(for the week of 16-20 February 1998)



Opposition to Indonesia's currency peg and RHB-BOC merger failure add to short-term weakness

We view the Indonesian economic, social and political situations as having a significant impact on the investing mood this week. On the local front, the collapse of merger talks between the RHB group and Commerce Asset-Holdings is expected to influence the market negatively. We would take buying opportunities when the market reverses closer to short-term support level of KLCI 650 pts.

Indonesia - currency or political stability? Indonesia has an unenviable task at hand about its currency problem: should it proceed with a currency board and incur the wrath of IMF (and risk the pullback of US$40b bailout package)? Food riots leading to next month's national election press authorities to stabilise the rupiah. But the economy is unprepared for the proposed solution.

Indonesia has courted expert advice to implement a fast-track development of a Currency Board to peg the rupiah, with the aim of stabilising the currency and the larger economy. Previously, the Central Bank would intervene to maintain the proclaimed forex parities. The currency board, however, would replace the Central Bank's national forex facilities with a pledge to hold sufficient forex reserves to trade the rupiah at a preset rate. Although the IMF assists in various countries' management of such pegs, it shares the view of the World Bank and US Federal Reserve in opposing the Indonesian plan. The peg plan nominally requires reserves to equal the country's base money, estimated at 78 trillion rupiah (or US$15.6b, if the peg is set at 5,000 per US dollar). This is the lion's share of Indonesia's current reserves of US$19b.

The establishment of such a mechanism would also compromise the central bank's monetary and interest rate control. Money supply and interest rates would be relegated to the vagaries of rupiah demand - as determined by any pronounced parities. Without the central bank as lender of last resort and guarantor of domestic deposits and loans, precarious banks with low capitalisation, high gearing and high nonperforming loans could become immediate casualties.

The peg plan undercuts the government's resolve to reduce future fiscal spending, since all state expenditure will have to come from fiscal budget outlays. It also requires the renegotiation of the IMF bailout package, as well as growth and interest rate targets.

Implications of RHB-BOC merger failure: Now that the RHB-BOC merger talks have collapsed, it's back to the drawing board again. The failure to achieve any progress of beyond the negotiation table is somewhat expected because of the lack of synergies. But the spiteful end to these merger negotiations looks as acrimonious as when it was broached two weeks ago. Both groups are helmed by politically-connected tycoons of differing alliance - Halim Saad is Daim Zainuddin's protege while Abdul Rashid Hussain is seen building bridges with Anwar Ibrahim. It should be clear to investors that relinquishing control was not negotiable to either party. It is also interesting to note that Commerce Asset-Holding has shifted its attention to state-owned Bank Bumiputra - previously tipped to be heading the RHB group's way. It lends some credence to talks that Rashid, who allegedly profited from the ringgit's meltdown, was (at some point) out of favour with the current leadership.

Of greater consequence, the failure spells deep resentment and distrust among well-connected groups prevailing in government-implored mergers, and will put a brake to the bandwagon effect on banking stocks in the equity market. Banking stocks could come back into play closer to the government-imposed March 31 deadline, but our view remains negative for this week.

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