The Indonesian rupiah continued its downward spiral on Monday morning (25/11). The central bank's mid rate fell 0.14 percent to IDR 11,722 per US dollar. Last week, the rupiah fell amid negative market sentiments brought on by the result of the Federal Reserve's FOMC meeting. The result seems to indicate that it will not take long before the quantitative easing program will be wound down. Contrary to the Australian dollar as well as the Indian rupee, news about the forthcoming financial reformation in China is unable to the support the rupiah.
There is a possibility that Indonesia's central bank will raise its benchmark interest rate (BI rate) again before the end of the year. Between June and November 2013, Bank Indonesia gradually raised its BI rate from 5.75 percent to 7.50 percent. The bank had several (inter-related) reasons for doing so. Firstly, Indonesia has been plagued by high inflation after the government increased prices of subsidized fuels in June 2013. Inflation may accelerate to 9.0 percent by the end of the year, notwithstanding the fact that the peak of inflation has already passed and is expected to be back at a normal level within a few months.
(annual percent change)
¹ Year to date (January-October 2013)
Source: Statistics Indonesia
Secondly, Indonesia has a wide current account deficit. Despite having eased from USD $9.8 billion (or 4.4 percent of Indonesia's gross domestic product) in the second quarter of 2013 to USD $8.4 billion (3.8 percent of GDP) in the third quarter, the current account deficit is still alarmingly high. By raising the BI rate, Bank Indonesia can cause a reduction of imports, thus improving the balance. The main problem of the current account deficit, however, is the huge trade deficit in the country's oil and gas sector.
Thirdly, a higher BI rate is one of the strategies to support the depreciating rupiah. Rupiah stability is in fact the most important task of the central bank. However, up to 25 November 2013, the rupiah weakened 21.2 percent against the US dollar in 2013.
Although most recent data indicate that inflation and the current account deficit have improved, the rupiah's depreciation remains worrisome and can make the central bank decide to raise the country's key interest rate one more time in 2013. Such a move could also be in anticipation of a future interest rate hike in the USA. If the US benchmark interest rate, currently only 0.25 percent, is raised it is expected to result in capital outflow from Indonesia.