Indonesia's current account deficit, which caused much alarm among the investor community, is expected to ease to about 2.5 percent of gross domestic product (GDP) in the second half of 2013. This assumption is supported by Indonesia's central bank and various analysts. The country's current account deficit reached USD $9.8 billion or 4.4 percent of GDP in Q2-2013. In combination with the weakening rupiah, higher inflation and the possible end to the Federal Reserve's quantitative easing program, investors have been pulling money out of Indonesia.
The country's trade balance has fallen into deficit (for seven consecutive quarters) as international demand for commodities has weakened sharply in recent years amid the global financial turmoil, thus affecting global commodity prices. As commodities (particularly raw ones) account for around 60 percent of the country's total exports, Indonesia feels the impact of the weak international market (demand from the country's important trading partners China and India has fallen significantly). Being a major commodity producing and exporting country implies being more susceptible to these effects of volatility in global commodity prices. In the 2000s, Indonesia felt the advantages during the commodities boom. Now, however, it is feeling the negative impact and as downstream processing industries, which deliver value-added products are still lacking, the situation cannot be reversed quickly. Meanwhile, robust economic growth in recent years, which added many new members to Indonesia's middle class, has resulted in a surge in imports. Most significantly, domestic demand for fuel skyrocketed while its domestic oil production has been in decline for over a decade. Therefore the government increasingly relied on the import of oil to meet domestic demand. However, as fuels are heavily subsidized by the government, it seriously pressured its budget balance and - despite public outcry - made the government decide to reduce fuel subsidies in late June 2013. This policy change should result in an easing trade deficit in the second half of 2013.
Indonesia's Current Account:
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Various analysts assume that Indonesia's central bank (Bank Indonesia) will raise its benchmark interest rate (BI rate) by 25 bps to 6.75 percent and its overnight deposit facility rate (FASBI) to 5.0 percent in September in order to combat the country's current high inflation rate (8.61 percent year-on-year in July), while supporting the rupiah. The BI rate has already been raised twice in recent months from a historic low of 5.75 percent to the current 6.50 percent. On the downside, a higher BI rate will limit national economic growth (real sector).
Inflation has surged in Indonesia because of the government's decision to increase prices of subsidized fuels in late June, higher food prices due to the holy fasting month of Ramadan and subsequent Idul Fitri festivities (in combination with mishandled government quotas that resulted in skyrocketing prices of certain food product such as beef), and the arrival of the new school year. The monthly inflation rate in July stood at 3.29 percent. As the impact of subsidized fuel prices, Ramadan and Idul Fitri celebrations and costs for the new school year will ease in August, inflation is expected to be around 1.3 percent this month (which is higher than the initial forecast of both the government and the central bank). Moreover, the government is planning to relax some import quotas related to food products as mentioned in the government's 'rescue package' that was announced last week. This package aims to safeguard Indonesia from global turmoil ahead of the ending of the Fed's quantitative easing program and to reverse the widening current account deficit. Still, inflation will continue its high pace this year and is likely to surpass the 7 percent mark at year-end 2013. Economic growth in 2013 will fall to the level of 5.5 to 5.9 percent as high inflation and a higher BI rate erode domestic consumption, which accounts for about 55 percent of the country's economic growth.