New Indonesian rupiah reference rate will boost offshore forwards

SINGAPORE - Offshore markets in the Indonesian rupiah are shifting to a new reference rate for trading the currency, one that will provide investors with a more credible and reliable hedge for their exposure to the volatile Southeast Asian economy.

Market regulators in Singapore announced on Tuesday that the non-deliverable forwards (NDF) market in the Indonesian rupiah will use a reference rate set by Indonesia's central bank to settle their expiring contracts, switching from a fixing rate that is now determined by banks in Singapore.

The Singapore Foreign Exchange Market Committee (SFEMC) has recommended that banks use the rupiah JISDOR (Jakarta Interbank Spot Dollar Rate) to settle NDF contracts from the end of March.

The announcement was anticipated by traders and fund managers who have for a while had to deal with wild swings in the rupiah offshore market, resulting in major divergences between onshore and offshore rates and therefore an inability to effectively hedge their exposure.

"Rupiah NDFs are once again a viable hedging option," said Siddharth Mathur, head of currency and rates strategy for Asia at Citi. "Now with the link to onshore restored, NDFs again become a proper hedge."

Indonesia's high-yielding markets are extremely sought after by emerging market investors. Most leveraged and real money investors use the NDF market to hedge exposure to the currency.

The divergences between NDFs and onshore rupiah forwards began last year when, following a long investigation by Singapore's central bank into collusion by banks in setting benchmark rates, Indonesian authorities introduced the JISDOR.

While the NDF market followed a reference, or fixing, set by the Association of Banks in Singapore (ABS), most traders onshore followed the JISDOR, a weighted average daily rupiah reference rate set by Bank Indonesia since May last year.

There was however a consistent variance between the two rates, since the NDF fixing was often skewed by the massive hedging flows. Onshore rupiah rates, meanwhile, were driven not just by portfolio flows but also the country's heavy trade payments and receipts.

Bank Indonesia last year urged local banks to use an onshore market-based benchmark to settle forward rupiah contracts. It bars onshore banks from using the NDF market.

The rupiah fell nearly 21 per cent against the US dollar last year amid capital outflows from emerging economies and on concerns about the country's current account deficit.

It has shown more resilience so far in 2014, rising 3 per cent despite a fresh bout of emerging market turmoil.


The offshore ABS fix on Wednesday had the rupiah at 11,790 per dollar, while JISDOR was 11,850 per dollar.

That discrepancy, traders said, was owing to the heavy one-sided flows in the NDF market, which caused lopsided moves in the fixing, irrespective of where the currency was traded onshore.

Volumes in rupiah NDFs, estimated to be less than a billion dollars a day, had shrunk in 2013 owing to the wide spread, or basis in market terms, between the two rates.

"The ability of funds to hedge was impeded by the fixing mechanism. As NDFs were not anchored, funds potentially faced mark-to-market swings on their hedge that would not represent their underlying exposure," said Citi's Mathur.

"The hedge could end up being a completely different position. Its correlation to the underlying could become coincidence rather than design."

The ABS explained in its statement that the switch to JISDOR as the reference rate was in keeping with its policy to using the most suitable benchmark for settling trades.

BNP Paribas said in a note that several real money investors had stopped participating in the NDF market as they saw it as dysfunctional.

"Their participation should now improve," BNP analysts said."Overall, we should see more interest and liquidity in the market.


This would naturally lower the risk premia on Indonesia assets," they wrote.

That pick up in interest has been evident over the past week, as rumours swirled in markets of the impending change in reference rates, with Indonesian bond yields at the longer end slipping between 50-70 basis points.

Credit default swaps, which are insurance contracts to hedge credit risk, should also move to price in a lower risk premium on Indonesian assets as some of the hedging that had been diverted to the CDS market moves back into NDFs, BNP said.

The spread between the onshore and offshore forward markets would eventually shrink, traders said, as both markets converged into the same reference rate.