The central bank of Indonesia (Bank Indonesia) expects that the country’s current account deficit will only ease slightly in 2014. Last year, the deficit reached 3.3 percent of Indonesia’s gross domestic product (GDP), a level which is generally considered unsustainable and leads to reduced investor confidence. Countries that have to cope with a wide current account deficit, such as Indonesia and India, are highly vulnerable in times of global shocks as investors will quickly withdraw their investments from assets in these countries.
When US interest rates are raised, possibly in 2015, emerging markets can expect another round of capital outflows (as happened in the second half of 2013 when heightened speculation about the winding down of the US quantitative easing program led to severe capital outflows from Indonesia).
Bank Indonesia Governor Agus Martowardojo stated on Monday (15/09) that the country’s current account deficit may only ease to 3.2 percent of GDP at the year-end. Previously, the central bank of Indonesia had stated repeatedly that it expected the deficit to ease to below the three percent of GDP mark; a level which is considered sustainable. Martowardojo emphasized that structural reforms are needed in order to improve the current account balance.
The main cause of Indonesia’s current account deficit lies in expensive oil imports to meet domestic fuel demand. Fuel consumption in Indonesia has risen sharply in recent years amid solid economic growth and generous government fuel subsidies. In the Revised State Budget of 2015 (RAPBN 2015), prepared by the Susilo Bambang Yudhoyono administration, the government allocated IDR 291.1 trillion (USD $24.7 billion) to fuel subsidies; a figure that is equal to 14.4 percent of total planned government spending in 2015. Thus, the incumbent government shows that it has no interest in making any structural reforms in an effort to improve the country’s fiscal situation. Meanwhile, domestic oil production has been in a state of decline for almost two decades due to a lack of investments and exploration in combination with maturing oil fields (making the country increasingly dependent on oil imports). It is up to the new government - led by Joko Widodo - to deal with these fuel subsidies. Although most investors and analysts agree with Widodo’s plan to reduce state spending on fuel subsidies (instead spending available funds on economic and social development), such a plan will meet resistance from the people and political opponents. The new government will be inaugurated on 20 October 2014.
The current account deficit also has a negative influence on the performance of the Indonesian rupiah exchange rate. The rupiah has been weakening since early 2012 (the structural current account deficit of Indonesia started in late 2011).
Indonesian Rupiah versus US Dollar (JISDOR):| Source: Bank Indonesia