Yesterday (24/08) it was the first time in 17 years that the rupiah weakened beyond the psychological level of IDR 14,000 per US dollar (a level that was used as worst-case scenario for several Indonesian banks’ stress tests until recently). For many policymakers, businessmen and consumers the current weak rupiah brings back traumatized memories of the Asian Financial Crisis in the late 1990s. Although Indonesia’s macroeconomic (and political) context is currently significantly different from that in the 1990s (and therefore it is highly unlikely to see another crisis), the weakening trend of the rupiah is remarkable and a cause of concern. Amid the US Federal Reserve’s tighter monetary approach and recent turmoil in China, Indonesia’s currency has weakened 13.1 percent against the US dollar since the start of 2015. And if we take the end of May 2013 as starting point (when former Federal Reserve Ben Bernanke first started to talk about a winding down of the US quantitative easing program), the rupiah has depreciated a staggering 43.5 percent against the greenback.

A weak rupiah should be positive for Indonesia’s trade balance as exports become competitive on the international market while imports become expensive (hence positively affecting Indonesia’s wide current account deficit). However, Indonesian exports - to a high degree - depend on commodity exports (not so much on manufactured products) and, problematically, prices of commodities have been touching six-year lows. As such, the improving trade balance of Indonesia is primarily caused by slowing imports, rather than accelerating exports (in fact Indonesia’s export performance is slowing but not as fast as imports). This also means that there is no real use for Indonesia to join a currency war (which was triggered by China’s recent decision to allow its yuan to devalue).

Instead, a weak rupiah has more negative side effects than positive ones and therefore Indonesia’s central bank is intervening in the market to support the currency. First, expensive imports cause imported inflation, while Indonesia’s inflation rate is already quite high at 7.26 percent (y/y) in July 2015. Secondly, the weak rupiah has serious consequences for foreign debt. At the end of Q2-2015, Indonesia’s external debt stood at USD $304.3 billion, comprising of USD $134.6 billion public sector external debt and USD $169.7 billion private sector external debt. About 25 percent of private sector external debt is short-term debt and due to the weak rupiah, some small and medium-sized enterprises could have serious difficulty to service their debt repayments. Thirdly, a weak rupiah makes Indonesian stocks unattractive as it cuts stock returns (but for others, especially those that are long-term minded, it provides an attractive entry point). It is assumed that with every one percent rupiah depreciation against the US dollar, market earnings per share growth declines by 0.8 percent.

To combat a further weakening rupiah, Indonesia’s central bank (Bank Indonesia) is heavily intervening in the market. One method is by using its foreign exchange reserves (worth USD $107 billion in late July 2015). Earlier, Bank Indonesia had already changed auction mechanisms of several monetary instruments and offers longer tenors to absorb banks' short-term liquidity in an effort to support the rupiah.

It was also announced today by Indonesian Finance Minister Bambang Brodjonegoro that the ASEAN region, which includes Indonesia, wants to push for the use of China’s yuan in international trade and investment purposes in the region as this would counter the further impact of bullish US dollar momentum (giving rise to more expensive imports and more difficulty to service debt repayments). Minister Brodjonegoro said Bank Indonesia is currently preparing such a mechanism.

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) depreciated 0.49 percent to IDR 14,067 per US dollar on Tuesday (25/08).

Indonesian Rupiah versus US Dollar (JISDOR):

| Source: Bank Indonesia

Indonesia’s benchmark stock index (Jakarta Composite Index) experienced a remarkable rebound on Tuesday, climbing 1.71 percent to 4,234.95 points, after falling heavily (in line with most other stock markets across the globe) the previous day, now known as “Black Monday”, when hundreds of billions of US dollars were wiped off the value of global markets. Stock markets across the world plunged on Monday on heightened concern about the Chinese economy after it let its yuan devaluate in an apparent move to boost the country’s export performance. The world’s second-largest economy may grow by the weakest pace since 1990 and this will surely have an impact on the global economy.

Today, the Indonesia Stock Exchange (IDX) tightened the limit on how much shares are allowed to decline to a maximum of 10 percent per day (from the range of 20-35 percent previously). It was also announced that several listed state-controlled companies will spend a combined IDR 10 trillion (approx. USD $712 million) for share buybacks in order to support the index.

Jakarta Composite Index (IHSG):