JAKARTA: he gradually weakening Indonesian rupiah is fast closing in on levels that will force foreign holders of the country's bonds to sell and exit the market to avoid losses.
The currency has weakened 1.8 percent against the dollar in the past week and 7.5 percent since March, trading around 12,165 per dollar on Tuesday.
That leaves it less than 2 percent away from levels where some analysts reckon returns on bonds no longer compensate for the losses suffered on the currency.
"If the rupiah hit about 12,300 to 12,400, we estimate there will be an outflow of about 10 trillion rupiah," said Handy Yunianto, head of fixed income research at Mandiri Sekuritas in Jakarta. An outflow of that size would be a small dent in the 455.19 trillion rupiah ($37.4 billion) foreigners hold in Indonesian government bonds. But there is a risk that the outflows could trigger a vicious cycle of selling, weakening the currency further and leading to a collapse in bond prices.
The foreign holding of government bonds in Indonesia is among the highest in Asia, at 37.4 percent of total outstanding bonds. The currency has been undermined by concerns over President Joko Widodo's ability to implement reforms.
Government coalition parties form a minority in parliament, and the expected monetary tightening in the United States could hurt economies like Indonesia that rely on foreign funding.
Yields on the bonds, among Asia's highest, have meanwhile been stable, encouraged in part by the government's pledge to rein in spending and raise the price of subsidised fuel - factors expected to strengthen the country's fiscal position.
Ten-year bonds offer 8 percent and have stayed within the 7-9 percent range since 2013.
Handy estimates foreigners hold bonds at an average yield of 8 percent - returns that the volatile currency is close to wiping out.
Most investors who use cash also do not normally hedge the currency risk, given the high costs of such protection.
"We are still expecting outflows, but if BI can hold the yield not to rise too sharply, the outflow could be manageable," said Aldian Taloputra, an economist at Mandiri Sekuritas, referring to Bank Indonesia (BI), the central bank.
Rising yields would imply additional losses for bond holders as prices fall.
A history of market volatility will keep fresh investors from coming into the market until the rupiah stabilises, even if bond yields are more appealing, analysts said. The central bank has said it will step in to buy bonds should the need to support the market arise. It has yet to do so.
Estimates of the levels at which foreign investors will break even on their bond holdings however vary widely.
Nizam Idris, head of strategy at Macquarie Bank, estimates the average rupiah exchange rate of 11,800 over the past year and an average bond yield of 8.8 percent mean that foreigners should be comfortable until the rupiah breaches 12,900.
"We think the market may already be pricing in 12,500 in dollar-rupiah and are willing to hold on to those positions, while the breaking point is probably closer to 13,000 where the rupiah could face a larger sell-off," Idris said.
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