| Source: Bank Indonesia

The recently depreciating rupiah exchange rate is the result of a lack of confidence in Indonesia's financial markets. Market participants are concerned about the impact of a winding down of the Federal Reserve's monthly USD $85 billion bond-buying program. This program has caused an inflow of US dollars into lucrative emerging markets in recent years. An end or winding down to the program will result in capital outflows from these emerging market, particularly from those markets that have weaknesses in their financial make-up. Indonesia, for example, is plagued by a wide current account deficit as well as high inflation.

Indonesia's current account deficit was USD $8.4 billion in the third quarter of 2013 (equivalent to 3.8 percent of Indonesia's GDP), thus improving from the USD $9.8 billion deficit (4.4 percent of GDP) in the previous quarter. According to Bank Indonesia (the central bank of Indonesia), however, a sustainable level would be between 0.25 and 2.5 percent of GDP. Finance Minister Chatib Basri said that the current account deficit will total USD $32 billion by the end of 2013, significantly up from USD $24 billion at the end of 2012.

Another factor that contributes to the depreciating rupiah trend is surging US dollar demand, which tends to peak near the end of the year because companies need US dollars for earnings repatriation and foreign debt payments. Harry Su, head of research at Bahana Securities, said that pressures on the rupiah are currently more intense because Bank Indonesia no longer supplies dollars for Pertamina, thereby forcing the company to enter the market to purchase dollars.

Lastly, on Monday (25/11), the government of Indonesia held a disappointing US dollar-denominated bond auction. Target of the bond auction was to raise USD $450 million. However, amid weak market sentiments, it only raised USD $190 million, thus significantly falling short of its target.

On Thursday (28/11), for the first time in more than four years, the rupiah broke through the psychological level of IDR 12,000 per US dollar on the spot market, which will intensify concerns. Bank Indonesia has permitted the rupiah rate to depreciate (instead of using its foreign exchange reserves) in line with the currency's fundamentals and global developments (currencies of other emerging markets also show a depreciating trend against the US dollar). Bank Indonesia assesses that the ideal level for the rupiah in the current economic context is IDR 11,500 per US dollar. This level is good for exporters while at the same time will curb imports (which constitutes a positive development in light of the current account deficit). However, some Indonesian entrepreneurs have requested Bank Indonesia to intervene in the market (by boosting its dollar reserves) to stabilize the rupiah because imports have become too expensive and thus hurts businesses that rely on the import of raw materials. Examples of businesses that feel the negative impact of a higher rupiah exchange rate are manufacturing companies, including textiles, footwear and food and beverages producers.

Since the start of 2013, Indonesia's rupiah has depreciated 23.86 percent against the US dollar. As long as Indonesia's financial context will remain gloomy, investors will be hesitant to re-enter the market.

¹ The Jakarta Interbank Spot Dollar Rate (JISDOR) is a USD/IDR spot price based on interbank foreign exchange transactions, for which the data is accessible in real-time through the Rupiah to Foreign Exchange Transaction Monitoring System (SISMONTAVAR) at Bank Indonesia.