A recent analysis of Indonesia’s central bank (Bank Indonesia) signals that the country’s private external debt is vulnerable to several risks i.e. currency risks, liquidity risks and overleverage risks.

Currency Risk

The currency risk is caused by private external debt being used by domestic-oriented companies to generate rupiah-denominated profit. However, the companies’ external debt needs to be repaid in a foreign currency making the companies vulnerably to currency fluctuations and volatility.

Liquidity Risk

Liquidity risk is growing amid a lack of hedging instruments in the country’s non-bank corporate sector. This risk has also been growing as the value and share of short-term private external debt is increasing.

Overleverage Risk

A growing debt-to-income ratio signals an increase in overleverage risk.

Governor of Indonesia’s central bank (Bank Indonesia), Agus Martowardojo, said that the new policy is particularly needed ahead of looming higher US interest rate. With the US Federal Reserve’s bond-buying program having been wound down completely it is only a matter of time before the Fed raises its key interest rate (expected in the second quarter of 2015). This will then trigger capital outflows from emerging economies including Indonesia thus placing depreciating pressures on the rupiah exchange rate, making it more difficult for companies to repay foreign-denominated debt.

Starting from 1 January 2015, Bank Indonesia forces Indonesian non-bank corporations (that hold external debt) to meet three requirements (trade debt, however, is exempted from these requirements):

1. a minimum hedging ratio of 20 percent for the period 1 January 2015 to 31 December 2015. The ratio increases to 25 percent from 1 January 2016. Bank Indonesia notes: “The ratio shall be applicable to the negative balance between foreign currency assets and foreign currency liabilities with a maturity period of up to three months and those that shall mature between three and six months.”

2. a minimum forex liquidity ratio; Indonesian non-bank corporations (that hold external debt) will be required to provide foreign currency assets totaling at least 50 percent of the value of foreign currency liabilities with a maturity period of up to three months in the period 1 January 2015 to 31 December 2015. From 1 January 2016, the liquidity ratio increases to 70 percent.

3. a minimum credit rating; Indonesian non-bank corporations (holding external debt) are required to have a credit rating of at least BB (or equivalent), issued by an authorized Rating Agency. “This requirement shall be effective for external debt signed or issued after 1 January 2016, but not applicable to refinancing or bilateral/multilateral external debt used to finance infrastructure projects.”

Bank Indonesia will also tighten rules regarding the reporting of foreign exchange (debt) flows.

Key Findings:

Indonesian external private sector debt has risen rapidly over the past decade jeopardizing the country’s macroeconomic stability

Bank Indonesia orders non-bank corporations that hold external debt to hedge foreign exchange holdings against the Indonesian rupiah