Although Indonesia is one of the victims of the reversal of investment flows from emerging markets to developed markets, it is still far from a crisis. Global uncertainty regarding the possible ending of the Federal Reserve's monthly USD $85 billion bond-buying program (QE3) and, to a lesser extent, the possible invasion of the US in Syria have worried investors and resulted in the withdrawal of funds from emerging markets. Funds are flowing back to western developed countries that have recently been showing signs of continued economic recovery.
Regarding domestic factors, investors fear Indonesia's current account deficit (which stood at USD $9.8 billion in the second quarter of 2013 and which is particularly caused by a trade deficit in the country's oil and gas sector) and higher inflation after prices of subsidized fuels have been raised in late-June (inflation reached 8.61 percent year-on-year in July).
Both these global and domestic factors have led to a weakening rupiah against the US dollar (the rupiah lost about 11 percent this year so far), a weakening benchmark stock index (the IHSG lost 8.70 percent this year), and soaring government bond yields.
These developments in Indonesia are part of a wider (regional) trend which sees the outflow of funds from emerging markets and results in falling regional currencies and stock indices. Indonesia's rupiah is Asia's third-weakest performing currency against the US dollar this year, after the Indian rupee (-13.71 percent) and Japan's yen (-10.89 percent). For Japan, which actively supports a weak currency to boost exports, it is a good development, confirmed by the strongly rising Nikkei index in 2013. For countries such as India and Indonesia (that run a trade deficit), a weakening currency puts more pressure on the current account balance.
Although Indonesia's economic growth has slowed down from around 6.5 percent (YoY) to the current pace of 5.8 percent (YoY), the country still posts one of the highest growth rates in Asia. Various international institutions (including the IMF and World Bank) expect Indonesia to keep growing between 5.5 and 6.0 percent in the years ahead as Indonesia can rely on robust domestic consumption (which accounts for about 55 percent of the country's economic growth) by the expanding and young middle class. However, recent high inflation as well as higher interest rates have somewhat eroded people's purchasing power. Policymakers are therefore eager to push inflation back to a normal pace (about 4.5 percent YoY), but this will probably take about ten months.
Inflation in August
Initial forecasts of the government and central bank (Bank Indonesia), which projected Indonesia's monthly inflation rate in August to be below the one percent mark, have already been revised upwards to about 1.3 percent. However, a Bank Indonesia survey indicates that in the first two weeks of August, inflation has already reached 1.3 percent and it is unlikely to expect that in the third and fourth week of August, Indonesia will experience deflation. In fact, inflationary pressures are still present. The price of soybeans, for example, has risen sharply due to a lack of supply as bad weather has impacted on harvests in America. Soybeans have an impact on the pace of inflation because it is a much-used commodity in Indonesia. There are also reports about a shortage of corn on Indonesian markets. Lastly, the weakening rupiah makes imports more expensive, which can result in inflationary pressures in the last two weeks of August.
Current prognosis: inflation in August (month-to-month) is expected to be 1.5 percent.