Indonesia Financial Market Update: Indonesia's Current Account Deficit

Indonesia's current account balance has suffered a deficit for 26 consecutive months. Starting in August 2013, the Indonesian government and central bank (Bank Indonesia) started to get serious about tackling the trade issue amid large capital outflows from Indonesia's capital markets as investors were concerned about the tapering of the Federal Reserve's massive monthly USD $85 billion bond-buying program known as quantitative easing. Through several policy packages, both have been trying to support the country's exports while curbing imports. Although these policy measures will need several months to be fully influential, the country's current account deficit did ease from USD $9.8 billion in the second quarter of 2013 (4.4 percent of GDP) to USD $8.4 billion in the third quarter. Bank Indonesia aims to bring the deficit back to a sustainable level of between 0.25 percent and 2.5 percent of GDP.

Why does resource-rich Indonesia have a current account deficit?

Some observers are puzzled why Indonesia - a resource-rich country with cheap labour - has a trade deficit. The current account deficit, a component of a country’s balance of trade, implies a negative net sales abroad. Generally, an emerging market (blessed with natural resources and cheap labour) posts a current account surplus. However, some recent developments have turned Indonesia into a net importer. Due to the global economic crisis commodity prices have plunged dramatically. Up to a few years ago, Indonesia could rely on huge revenues through the export of coal and palm oil. These foreign exchange earners have now largely vaporized, while the import of expensive oil has continued amid Indonesia's huge and rapidly increasing fuel demand. The trade deficit in Indonesia's oil and gas sector is in fact a major contributing factor to the current account deficit.

Indonesia's central bank uses various strategies to curtail the current account deficit. Between June and November 2013, it has gradually raised the country's benchmark interest rate (BI rate) from 5.75 percent to 7.50 percent. Although the main aim of this policy adjustment was to curb high inflation after the government raised prices of subsidized fuels in June 2013, it also impacts on the current account deficit because it reduces imports. Besides the impact of the higher BI rate, Bank Indonesia also intends to curb the growth of banks' credit loans to 15-17 percent (yoy) in 2014 from the pace of +20 percent annually in recent years by using its liquidity management tools such as the minimum reserve requirement and loan to deposit ratio.

Improving the country's current account is important as it has been a big concern of investors and thus makes Indonesia more vulnerable (than other emerging economies) to capital outflows when the Federal Reserve starts to wind down quantitative easing.

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