Analysis Indonesian Rupiah & Stocks: High Market Volatility

The value of the rupiah is now close to a 17-year low. In late 1998, Indonesia - Southeast Asia’s largest economy - was in the early stages of recovery from the Asian Financial Crisis. This crisis became one of the largest watersheds in modern Indonesian history, starting as a financial crisis but rapidly expanding into a social and political one which marked the end of President Suharto's authoritarian New Order regime (a regime that was legitimized by economic development). Among the region’s nation-states, Indonesia would become the one that was hit hardest by this crisis and it reversed much of the economic progress made under Suharto’s New Order regime (for instance the country’s poverty rate slipped back from 11 to 19.9 percent in late 1998). As such, for many Indonesian people, market participants and policy makers the current weak rupiah brings back bad memories.

Despite having depreciated beyond the government’s macroeconomic assumption in the Revised 2015 State Budget (APBN-P 2015), in which the rupiah was set at IDR 12,500 per US dollar, Indonesian Finance Minister Bambang Brodjonegoro said that the current weak rupiah would not pose significant risks to the state budget deficit. Both Indonesia’s central bank (Bank Indonesia) and the Finance Ministry have calculated the impact of rupiah depreciation on the country’s budget deficit and concluded that the impact is small (by law Indonesia’s budget deficit is required to be maintained below 3 percent of gross domestic product). The government expects that this year’s state budget will see a deficit of IDR 245.9 trillion (USD $19.1 billion), equivalent to 2.21 percent of GDP. According to the calculations, the state budget deficit widens in the range of IDR 3.5 trillion - 4.2 trillion for every IDR 100 depreciation against the US dollar.

Bank Indonesia announced that it has intervened in the market to combat high volatility (a move that was likened by investors). Deputy Governor Mirza Adityaswara emphasized that people should not forget that the Indonesian rupiah is not the only currency that has been depreciating against the US dollar but the strong US dollar is a worldwide phenomenon. Meanwhile, a positive development for the rupiah is that the country’s foreign exchange reserves rose. On Friday (06/03), Bank Indonesia announced that the forex reserves stood at USD $115.5 billion at end-February, from USD $114.2 billion in the preceding month. The growth was (mainly) attributed to a surplus in the country’s oil & gas balance.

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 0.29 percent to IDR 12,983 per US dollar on Friday (06/03).

Indonesian Rupiah versus US Dollar:

| Source: Bank Indonesia

Why has the Indonesian rupiah been depreciating?

• Investors are anticipating higher US interest rates. The US Federal Reserve’s decision to raise borrowing costs is expected to result in capital outflows from emerging markets as the gap between yields in (lucrative yet risky) emerging markets and the USA becomes smaller. As recent economic US data indicates that the world’s largest economy has been experiencing structural economic recovery, US interest rates will rise sooner than later, resulting in recent worldwide bullish US dollar momentum. Similarly, when the Federal Reserve started speculating in mid-2013 about winding down its quantitative easing program, the Indonesian rupiah started to depreciate sharply. In 2013, Indonesia’s currency lost over 25 percent against the US dollar due to investors anticipating monetary tightening in the USA.

• Being Indonesia’s main trading partner, the economic slowdown in China will also negatively affect Indonesia, not only in terms of economic expansion but also regarding the currency value. Last week, policy makers in China said that the economy of China is expected to expand a mere 7 percent (year-on-year) only in 2015, significantly down from an earlier forecast of 7.5 percent (y/y) and constituting the lowest growth target of China in 15 years. A weaker Chinese economy will result in reduced demand for Indonesian exports thus placing pressure on Indonesia’s trade balance and the rupiah.

• Indonesia has been plagued by a structural current account deficit since late 2011. This deficit signals that the country depends on foreign inflows and therefore makes the country vulnerable to capital outflows in times of economic turmoil (for example the higher US interest rates expected to be implemented in mid-2015). Indonesia’s current account deficit - the broadest measure of trade in goods and services - improved to 2.81 percent of GDP, or USD $6.2 billion, in the fourth quarter of 2014 (from a revised 2.99 percent of GDP in the preceding quarter). Over the whole year of 2014, the current account deficit was USD $26.2 billion, equivalent to 2.95 percent of GDP from a (revised) deficit of USD $29.1 billion (3.18 percent of GDP) in 2013. Generally, a current account deficit of over 3 percent of GDP is regarded unsustainable. Indonesia is still very close to that boundary. In fact, Bank Indonesia expects that the deficit will widen to about 3.1 percent of GDP in 2015.

• In mid-February, Bank Indonesia made a surprise move by cutting its key interest rate (BI rate) by 25 basis points to 7.50 percent. Although this opens up room for accelerate economic growth in Indonesia, it also places pressures on the rupiah exchange rate.

• Although concerns have somewhat eased over the past week, a possible Greek exit from the Eurozone (and/or default) would bring trouble for emerging market assets. The Greek government seems committed to implement reforms and made its first €300 million payment to the International Monetary Fund (IMF) on Friday. However, cooperation between the European institutions and Greek government remains a ‘slippery and uncertain road’.

Meanwhile, Indonesia’s benchmark stock index (Jakarta Composite Index, abbreviated JCI) has set another all-time record high. On Friday (06/03), the JCI climbed 1.17 percent to 5,514.78 points. The rise was mainly the result of foreign funds entering the market. As usual, it are Indonesia’s blue chip stocks that benefit most when foreign investors record net buying. Positive market sentiments were caused by Bank Indonesia’s statement that the country’s foreign exchange reserves grew in February 2015 and the slightly appreciating rupiah on Friday.

Jakarta Composite Index:

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