Currency Struggling for Stability
Executive Summary
We may see rupiah depreciation deepen, given intensifying public purchases of dollars and waning confidence in the Central Bank’s ability to defend the currency. Having topped Rp. 10,000 per dollar, and drifting lower, the rupiah is now seeking a new equilibrium level.
Several factors are driving depreciation. First is the global reaction to the tapering off of U.S. economic stimulus, as signaled by the Federal Reserve. Second is the trade deficit, particularly due to the rising demand for oil imports. Third are climbing prices, which drive inflation higher.
So, even though the rupiah has devalued in line with other emerging market currencies, in Indonesia there have been exacerbating factors. Yet rupiah depreciation is still less than for other key currencies, such as the Chinese yuan, the Indian rupee and the Korean won. However, the difference between the rupiah and those currencies was their different starting positions: the rupiah was close to the psychological barrier of Rp.10,000 when depreciation started intensifying. Public jitters then deepened the devaluation.
The Central Bank has been struggling to stabilize the situation, via FX market intervention. Bank Indonesia recently reintroduced the Central Bank swap facility, which could entice private financial institutions into trades. Simultaneously, aiming to anticipate and contain inflation, the Bank has raised the domestic benchmark rate for two months in a row. The new rate, after two 25 bp hikes, is 6.5%.
The May trade balance was again significantly in deficit, though by far less than in April. While not publicly noted, we think the deficit is related to the Muslim holiday of Ramadan. Each Ramadan, company sales boom. So, two to three months beforehand, company production activity likewise peaks, amid massive raw materials imports. The surge in imports therefore produced a spike in the trade deficit. After the holiday, the deficit shrinks.
Several big infrastructure projects are nearing completion, and two new ones, the Trans Sumatera Highway project and the Java-Sumatera Bridge, are on the horizon. Through these and other infrastructure initiatives, Indonesia is firmly preparing itself for its next stage of development.
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