* Domestic transactions must be in rupiah from July
* About 10 pct of domestic transactions now in dollars
* Firms say may settle in rupiah but still price in dollar
* Some warn of inflation pressure to counter exchange risk
By Fransiska Nangoy
JAKARTA, May 20 (Reuters) - As Indonesia prepares to ban domestic use of the dollar to build faith in its own currency, it might succeed in taking the greenback out of local hands, but much of the benefit of the reform will be lost as local heads still calculate in dollars.
Many businesses say they will still effectively be hostage to gyrations in Indonesia’s volatile rupiah after the new rule takes effect in July, and inflationary pressures could emerge as companies try to build in buffers to counter the loss of dollar certainty.
Distrust of the rupiah, emerging Asia’s worst-performing currency this year, runs deep in an economy where high interest rates and a history of hyperinflation have pushed companies to borrow in dollars and also bill in dollars for many local goods and services.
About 20 percent of office towers in Jakarta charge their tenants rent in dollars, for example, and Bank Indonesia estimates about 10 percent of domestic transactions are conducted in dollars, $6 billion every month.
Mandating use of the rupiah for contracts drawn from July 1 will alleviate some pressure on the currency by reducing a small amount of dollar demand, but many local businesses say they will still negotiate and price in dollars, then settle in the local currency.
State power utility PT Perusahaan Listrik Negara (PLN) bills its customers in rupiah, but it needs about $600 million in foreign currency every month to pay local coal miners and power producers and to service its loans.
Under the new regulation, PLN’s payments to local producers can no longer be in dollars, and while that would in theory suit the company, in practice, the rupiah price it pays will still be determined by dollar exchange rates.
“We are still negotiating, but even when we agree to set the contract in rupiah, we have to discuss the exchange rate that will be used,” says Tjutju Kurnia, head of treasury at PLN.
Its vendors have liabilities in dollars, she said, so they have to build in foreign exchange risk.
Some vendors, such as state-controlled coal miner Bukit Asam , with whom PLN has two power purchase contracts, have already adopted settlement in rupiah, but they still quote prices in dollars.
Bukit Asam’s corporate secretary said the firm had a calculation system in place and every dollar cost in their investment or production activities was converted into rupiah.
Heavy equipment distributor and mining contractor United Tractors sells all its products and services in dollars “simply to match cash in and cash out”, said corporate secretary Sara Loebis.
Loebis said United would comply with the new rules but it might mean more risks for the firm.
In the textiles industry, Indonesia’s second largest manufactured goods exporter, every transaction in the supply chain except labour costs is in dollars.
Electricity bills are settled in rupiah but they fluctuate every month because the charges are dollar-based. The fibre and the spinning industries also pay for raw materials in dollars and sell products locally in dollars.
“If Bank Indonesia requires this industry to convert their dollars to rupiah, I‘m afraid their prices will not be competitive with products that are directly imported,” says Ade Sudrajat of Indonesian Textile Association.
Leo Putra Rinaldy, an economist at Mandiri Sekuritas, warns that an unintended consequence of the new rules could be inflation, as companies err on the side of inflated rupiah values to hedge against currency swings.
“There would be companies that set the rupiah exchange rate based solely on their expectations, and mark them up,” said Rinaldy. “If you are a single producer or single supplier, you have the power to do that, but if it is a competitive market, buyers would look for better pricing.”
Such incidental costs weigh against the benefits of the new regulation, which doesn’t address the main source of rupiah volatility: the economy’s dependence on foreign capital and its vulnerability to capital flight in times of trouble or when U.S. interest rates start rising, as expected later this year.
At last count, foreign investors held 38.4 percent of the outstanding value of Indonesian government bonds.
“At the margin, the policy can help a little bit. Our longer term view is that rupiah can stabilise, but it won’t really be driven by that kind of regulation,” said Victor Rodriguez, head of Asia Pacific fixed income at Aberdeen Asset Management Asia Ltd. (Editing by Vidya Ranganathan and Will Waterman)