In the second quarter of 2018 Indonesia's current account deficit widened to USD $8.02 billion, or 3.0 percent of the nation's gross domestic product (GDP), the biggest deficit since Q2-2014. Generally, 3 percent of GDP is regarded the boundary between a sustainable and an unsustainable current account deficit. However, we emphasize here that an accurate judgement would also include the exact (economic) context because when a big deficit is used to generate future revenue streams, then it should not be labelled unsustainable. Instead, in that case, the (temporary) deficit is used to strengthen the economy.

In the case of Indonesia, however, capital inflows lead to limited future revenue streams (for example capital inflows in the form of investment in export-oriented industries) and therefore investors in the financial market rapidly sell Indonesian assets when there occurs global economic turmoil, thus resulting in a selloff in bonds and stocks that also affects the rupiah. That is why Indonesian authorities (the central government and central bank) are eager to limit the current account deficit by reducing the need for fuel imports (through the implementation of the B20 biodiesel program), imposing higher import tariffs on specific goods, and postponing the development of various power infrastructure projects that require a high degree of imports.

Problematically, however, such infrastructure projects do lead to a stronger economy in the long term, albeit (on the short term) putting pressure on the currency and therefore opinions are mixed about the government's decision to delay various projects. The government seems particularly keen on defending the rupiah ahead of the legislative and presidential elections in April 2019. Political opponents of the incumbent government particularly use rupiah weakness and stagnant economic growth (around the 5 percent year-on-year mark) to undermine peoples' support for the incumbent government. In that sense, delivering a stronger rupiah would increase chances for incumbent President Joko Widodo to be reelected.

As mentioned above, the monthly trade balances of July and August 2018 - involving a USD $2.03 billion and USD $1.02 billion deficit, respectively - are not a good omen for Indonesia's Q3-2018 current account balance. However, usually pressures on the country's current account deficit ease in Q3 and Q4 as there is less foreign exchange demand for debt settlements and dividend payouts (compared to Q2).

Indonesia Investments, for now, keeps its outlook for Indonesia's full-year 2018 current account deficit at 2.5 percent of GDP. We expect all government efforts to strengthen the balance are to be felt in 2019, not in 2018. Therefore, we expect the country's current account deficit to improve to 2.0 percent of GDP in 2019.

We move more and more in-depth analyses from our website to our monthly research report. This report can be purchased here.

Poll Indonesia Investments:

Who would you vote for in Indonesia's 2019 presidential election?

Voting possible:  -

Your vote

Discuss