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One day removed from the respite of festivities marking 70 years of independence, Indonesia on 18th August 2015 woke up to the harsh reality of a local currency spiralling to its lowest level in nearly two decades. Having sunk beyond 13,800 IDR against the dollar and with no clearly defined strategy in place to stymie a free fall, the Indonesian rupiah is in an uncertainty-fuelled state of limbo, leaving investors to speculate as to how low it can go.
International focus on this trend has been particularly intense, given Indonesia’s ongoing struggle to reverse a recent pattern of slowing economic growth, which in Q2 2015 fell to 4.67% year-on-year from 4.70% in Q1 2015. Perceived by onlookers as yet another sign of a new government failing to live up to expectations, the weakening rupiah is oft-referenced in tandem with slow government spending and declining consumer confidence as evidence of a challenging new economic landscape in Indonesia.
The currency’s position, however, should not be thought of as an indictment against Indonesia’s economic fundamentals. Events on the global stage outside of the country’s control play a large part in the decline of the rupiah and have had major implications for a broad swathe of emerging economies.
Foremost among these events is the anticipated increase in US interest rates to be carried out by the Federal Reserve (Fed). Emerging markets have been riding the wave of strong economic growth for the past several years under supportive conditions attributed to the Fed’s well-documented quantitative easing (QE) measures. International investors on board with the Asian growth story during this period of time channelled a large volume of capital into developing markets such as Indonesia and Malaysia, and the resulting inflow of money supply through purchases of treasury bonds and mortgage-backed securities by the US led to stabilisation in Asian currencies.
This stability has since been thrown into disarray, following on from the release of US government data signalling strong improvements in the market’s economy and the subsequent expectation that the Fed will soon move to hike interest rates. As the US economy continues to recover and global appetite for the greenback rises, Indonesia has had to contend with bearing the brunt of uncertainty pertaining to the projected exodus of capital and has seen its currency waver ever since the prospect of QE tapering by the Fed was announced in 2013. In this regard, Southeast Asia’s largest economy is not alone – Malaysia, Myanmar and Thailand have suffered a similar dip in performance versus the US dollar.
Currency Performance Decline versus the US Dollar, 2014 to 2015 (in %)
Source: “Ringgit falls to a new low”, The Star, 13th August 2015
Following on from the latest decline in the rupiah as a result of growing speculation that the US interest rate hike will take place next month, Bank Indonesia officials now see the rupiah as being undervalued and have taken steps to intervene in the currency market. Crucially, however, they also view this position as temporary and not indicative of the country’s strong economic standing. Certainly, a look into trends among investors with long-term interests in the country – such as an uptick in Q1 and Q2 2015 foreign direct investment (See FDI Growth: A Timely Reminder of Long-term Upside) – suggest that the rupiah’s present struggles are not putting a damper on foreign investors’ appetite for Indonesia.
Adding fuel to the fire is an across the board decline in the global prices of commodities; a turn of events that marks the cessation of a period of rising prices dating back to the early 2000’s. The waning of China’s previously robust economic performance has seen aggregate demand for raw materials decline, with Indonesia’s main export commodities of coal and crude palm oil among the hardest hit thus adversely affecting the country’s trade balance and further devaluing the rupiah.
China’s role in compounding the decline of the rupiah extends to its recent move to devalue the yuan, a shock decision that has brought about fears of a currency war and heightened economic uncertainty. The yuan devaluation policy on China’s part could be its own counter-measure to maintain its range against the US dollar while also managing the currency’s exchange rate against that of other main trading partners such as the euro and the yen. The immediate knock-on effect nonetheless was the rupiah strengthening by 1.9% against the yuan while simultaneously reaching a low against the US dollar last recorded in 1998.
The long-term implications of a slide in the yuan for Indonesia are still the subject of discussion, though exports to China as one its primary trading partners are likely to suffer. On a wider scale, the availability of cheaper Chinese exports may impinge upon the penetration of Indonesian products overseas, though areas of direct competition may be limited as China shifts its focus to value-added manufacturing and Indonesia continues to bank on inexpensive, unskilled labour for growth in the manufacturing sector. Moreover, local businesses still reliant upon imports from China will benefit from the yuan’s decline, particularly as Indonesia gears up to carry out massive infrastructure development plans requiring components and machinery sourced abroad (See Concrete Developments in Indonesia's Infrastructure).
In diagnosing the current state of the rupiah, it is also worth keeping in mind that a weakened currency is not without its own advantages for Indonesia. A government-led push to increase exports and curb the use of imports provides some justification to refrain from taking strong action to stem the rupiah’s decline. The weakening of the rupiah comes at a time when the government has prioritised narrowing the country’s current account deficit by cutting fuel subsidies amid major obstacles such as the aforementioned global decline in commodity prices and a general slowdown of the economy. As part of the effort to further improve upon the current account deficit, allowing the rupiah to depreciate is another step to boost the competitiveness of exports on the global stage. Seven consecutive months of trade surplus from January to July 2015, suggests that this course of action – or rather inaction in reacting to the rupiah’s decline against the dollar – has been successful. The fact that the majority of this surplus can be attributed to a substantial decrease in imports as opposed to a jump in exports (which actually declined by 19.2% y-o-y in July), however, paints a more worrying picture for the local business climate.
Taken together, the factors behind the rupiah’s current position should dissuade direct comparisons with the 1997 Asian Financial Crisis. Much of the Indonesian rupiah’s decline against the dollar can be attributed to global conditions bearing down on emerging economies – particularly those dependent upon commodity exports – as well as the government’s motivation to maintain a weak currency as a means of addressing a current account deficit.
Yet, whilst it is true that the decline of the rupiah should not be seen as evidence of deep-seated deficiencies in Indonesia’s economic fundamentals, the ongoing slowdown in GDP growth has undoubtedly accelerated the outflow of capital. A mass sell-off of local stocks, bonds and currency has been made worse by lower investor confidence and growing concerns over the country’s lack of progress in carrying out highly-touted infrastructure development.
Given the combination of factors at play, pinpointing the Indonesian rupiah’s trajectory is an exercise in speculation, dependent upon the actions of a number of governments with disparate interests. In seeking to avoid conjecture on proposed timeframes to make projections such as year-end exchange rates, suffice it to say that the eventuality of the Fed’s interest rate hike will see the Indonesian rupiah continue to weaken against the dollar. Whether or not this course of action will take place in September 2015 – as suggested by positive results in the latest US jobs report – affects only the ‘when’ and not the ‘if’ of the next rupiah decline.
With that said, the looming interest rate hike in the US should not be seen as a death knell for emerging market currencies. Accompanying the unavoidable decline in the rupiah as a result of a US interest rate hike will be the relief of greater certainty and an end to the cloud of speculation that has hung over Indonesia since the Fed’s announcement of QE tapering in 2013. This sentiment has led prominent Indonesian policymakers such as the former Coordinating Minister for Economic Affairs, Mr Sofyan Djalil to be among those most actively calling for the Fed to proceed with raising its interest rates.
Moreover, questions remain as to the actual magnitude of the impending (further) weakening of the rupiah against the dollar. It has been posited that the rupiah’s current value already prices in the Fed’s decision to increase interest rates, as seen in the initial plummet in the exchange rate from less than 10,000 IDR per dollar to more than 12,000 IDR in late 2013 after Mr Ben Bernanke, then Chairman of the Federal Reserve, laid out plans to begin QE tapering.
A further drop in the rupiah – even one of a small magnitude – spells trouble for import-reliant local businesses already struggling with rising costs associated with previous declines in the currency. Reports of widespread closures and lay-offs in key industries such as textiles have driven the government to impose highly protectionist policies such as new import tariffs on consumer goods (See Indonesia Raises Import Tariffs on Consumer Goods), and similarly short-term-oriented measures may be en route to quell the negative repercussions felt by local companies as a result of an even weaker rupiah. Certainly, more long-term-minded reform such as addressing high logistics costs and excessive red-tape is likely some way away following on from a recent reshuffling of President Joko Widodo’s cabinet and the subsequent need for an adjustment period.
As to whether Bank Indonesia will forcefully step in to prevent the currency from falling beyond a certain threshold remains to be seen, though recent reports from the House of Representatives suggest that the limit stands at 15,000 IDR per dollar. More apparent is the central bank’s intention to continue its current intervention strategy centred around the sale of foreign currencies and the purchase of Indonesian bonds on the secondary market. A scaling up of these initiatives is one of the only tools left available to BI in the event of a currency free fall, given that taking action to increase interest rates would have an adverse effect on economic growth already trending at a six-year low. Indonesia is thus precariously positioned – teetering between the challenges of disappointing economic performance (and its associated impact on consumer confidence and spending) and a currency creeping up on its all-time low – and vulnerable to unforeseen shocks such as a hypothetical increase in oil prices that would force its hand in taking drastic action in one direction or another.
Global Business Guide Indonesia - 20th august 2015
Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)
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