After a series of good economic data (particularly US employment) the market expects that the Federal Reserve will raise its key interest rate in the second or third quarter of 2015 thus providing ammunition for bullish US dollar momentum (hovering at an 11-years high). Due to the expected higher yield in the USA, capital is flowing back to the world’s largest economy at the expense of emerging market currencies, including the Indonesian rupiah exchange rate which has depreciated 6 percent against the US dollar this year so far.
The central bank of Indonesia (Bank Indonesia) has signalled on various occasions that it is comfortable with a weak rupiah. Although the institution decided to intervene several times (using its foreign exchange reserves) to soften the rupiah’s fall against the US dollar in recent weeks (in order to avert a plunge), Bank Indonesia considers that the weak rupiah is a remedy for the country’s ailing current account deficit as it makes Indonesian export products more competitive on the global market and therefore should lead to a stronger rupiah on the longer term. This stance was also a reason why Bank Indonesia cut its key interest rate (BI rate) by 25 basis points to 7.50 percent on 17 February 2015 (supported by the country’s easing inflation). Although this move provides room for accelerated economic growth in Southeast Asia’s largest economy (which has moderated to a growth pace of 5.02 percent y/y in 2014, or, the slowest pace in five years), it also provides additional pressures on the rupiah rate. Since Bank Indonesia’s interest rate cut in mid-February, the rupiah has weakened 3.4 percent against the US dollar.
Indonesian Rupiah versus US Dollar (JISDOR):| Source: Bank Indonesia
Indonesia has been plagued by a structural current account deficit since 2011, primarily due to a wide deficit in the country’s oil & gas trade balance. The current account deficit narrowed to 2.95 percent of gross domestic product (USD $6.1 billion) in 2014 from 3.18 percent of GDP in 2013. However, in 2015, the current account deficit is expected to widen again. Bank Indonesia estimates that the deficit will stand at about 3 percent of GDP at the year-end. Although, the country’s oil & gas trade balance should improve markedly this year on low global oil prices (Indonesia being a net oil importer) and the government’s subsidized fuel policy reforms, imports will remain high this year due to imports of capital goods for infrastructure development. This is a positive change regarding the country's import composition.
The Indonesian government is also eager to improve the country’s current account balance, the widest measurement of foreign exchange flows, including trade, services, interest payments and remittances. The government announced that it plans to provide exporters (who export a certain amount of their products) a tax allowance. Companies that reinvest their profits (instead of repatriating these earnings) can also count on tax breaks. Companies will be given a 30 percent cut in income tax bills for a five-year period, a longer loss carry forward period of 10 years, and an income tax rate of only 10 percent on repatriated dividends. The government further plans to impose a temporary anti-dumping import tax on steel and textile products in a move to curb imports (anti-dumping import tax measures will now be implemented immediately without needing to wait for results of a formal investigation first). The government also plans to give visa exemptions to another four countries to boost foreign visitor arrivals and foreign exchange earnings in the tourism sector. These countries are Japan, Russia, China and South Korea. Lastly, the government plans to raise the ethanol content requirement in (palm oil-derived) biodiesel to 15 percent (from 10 percent currently) in a move to reduce imports of diesel fuel. In the future, this figure will be elevated to 20 percent and 30 percent. Although Indonesia missed its biodiesel targets in 2014 - mainly on logistical and infrastructure troubles - the government is still eager to protect its biofuels industry against the globe’s low crude oil prices, hence providing more biofuel subsidies.