Weakening Rupiah due to Indonesia's Fundamentals and Profit Taking
The Indonesian rupiah (IDR) is experiencing one of its worst losing streaks in a decade. On Friday (19/07), the currency weakened to IDR 10,070 against the US dollar, which implies a devaluation of 4.14% in 2013 so far. The central bank of Indonesia, Bank Indonesia, does all it can to support the currency: the country's lender of last resort supplies dollars to the market triggering the reduction of foreign reserves from USD $105 million at end-May to $98 million at end-June, and raised its benchmark interest rate (BI Rate) by 50 bps to 6.50%.
But despite these tactics by Bank Indonesia, the rupiah continues its steady downward trend. For investors it means that they prefer to wait-and-see before (re)entering the Indonesian market as a depreciating currency can harm investments.| Source: Bank Indonesia
The reduction in value of the Indonesian rupiah is not only due to profit taking in the country's bond and capital markets (since June 2013, foreign investors have pulled hundreds of millions of dollars from these markets) but the situation is also due to the economic fundamentals of the country. A number of economic indicators have been on a downward trend since 2011 and make investors nervous.
The table below shows that Indonesia's gross domestic product (GDP) follows a similar trend. From 2011, growth has been slowing down. The government still targets an annual growth rate of 6.2 percent in 2013 but it will not be easy to meet that target as global demand for Indonesia's commodities has not picked up yet (commodities account for about two-thirds of the country's exports) and triggered a large trade deficit, which subsequently places pressures on the rupiah and Indonesia's inflation rate.
Economic Growth 2007-2013 (annual percentage change)
|Year|| Quarter I
||Quarter II||Quarter III||Quarter IV|
Source: Statistics Indonesia (BPS)
Inflation has been on an upward trend and might reach to 8.0 percent in 2013. Last month, the government of Indonesia increased prices of subsidized fuels significantly, which leads to serious inflationary pressures. In June, the country's inflation rate stood at 5.90 percent (YoY). However, it is expected that higher subsidized fuel prices will make its hardest impact in July and August. Monthly inflation may reach over 2 percent in July.
The reason why the government has increased fuel prices is to relieve the government budget deficit and try to turn the trade deficit back into a surplus again. Large and expensive oil imports are the main reason why the country has been posting trade deficits in recent years. Therefore, despite triggering immediate high inflation, the reduction in fuel subsidies is believed to have a good impact on the country's fundamentals in the medium and longer term, including the performance of the rupiah.
Inflation in Indonesia:
(annual percent change)
¹ year to date
Source: Statistics Indonesia
However, the depreciation of the rupiah is also part of a wider trend as the economy of the United States is recovering and an end to the Federal Reserve's quantitative easing program is in sight. Various currencies of emerging economies in Asia are weakening against the US dollar. The Thai baht, Indonesian rupiah and Indian rupee are expected to be the worst performing Asian currencies in 2013. Moreover, weak economic data from China (indicating slowing economic growth in the world's second largest economy) adds pressures to regional currencies.