Why the Indonesian Rupiah Exchange Rate has been Depreciating Lately

The monetary policy of the US central bank (Federal Reserve) has a huge impact on the global money flows. When the Federal Reserve prefers monetary easing (through the bond-buying program and low interest rates), in an attempt to support US economic growth, then funds flow to emerging economies, including Indonesia. However, when the US central bank tightens its monetary policy amid an improving US economy, funds flow back to the world’s largest economy.

At the latest Federal Reserve meeting (17-18 June 2014), the institution decided to cut its forecast for US economic growth in 2014 from the range of 2.8 to 3.0 percent (year-on-year, yoy) to the range of 2.1 to 2.3 percent (yoy), particularly due to the negative impact of the severe winter weather in the USA. However, the Federal Reserve also indicated that several economic data have suggested the continuation of an improving US economy in recent months (particularly the easing unemployment rate). As such, it decided to continue to wind down the bond-buying program by another chunk of USD $10 billion per month (to USD $35 billion per month in June). Since December 2013, the US quantitative easing program has been wound down five times, and may end altogether in the fall of 2014. The next logical step of the Fed would then be to raise interest rates which are now close to zero (0.0 to 0.25 percent), effectively ending the recent era of cheap US dollars. When this last step will be taken remains unknown but most analysts and market participants see it happening in 2015. The latest statement of the Federal Reserve did not clarify the matter as it stated that US interest rates will be kept near zero for a ‘considerable time’, although this statement manages to temporarily curb US dollar demand (as we see on today's trading day where most emerging currencies are gaining against the greenback).

But in the context of US monetary tightening, market participants will prefer to transfer their capital to safer assets. Particularly those emerging economies that show weaknesses in their financial make-up, for example those markets that are dependent on volatile foreign capital inflows to fund the current account deficit, are highly susceptible to capital outflows. Indonesia is one of these countries. Since 2011, it has been recording a current account deficit, particularly due to a large trade deficit in the oil & gas sector (Indonesia imports expensive oil to meet domestic fuel demand).

Related to Indonesia’s trade balance is the current geopolitical turmoil in northern Iraq. These troubles disturb the oil supplies from the Middle East, thus giving rise to higher global oil prices. As Indonesia is a net oil importer (domestic oil production has been in a state of decline for more than a decade), higher international oil prices put more pressure on the country’s trade balance. Ironically, the trade deficit in Indonesia’s oil & gas sector is partly self-inflicted as the government subsidizes a considerable portion of domestic fuel prices.

Domestically, increased private debt has been a cause for concern. In April 2014, private debt in Indonesia was estimated at USD $145.6 billion (from a total debt figure - including government debt - of USD $276.6 billion). As private debt usually constitutes short-term debt, it will result in significant US dollar demand (needed for debt settlements) in the next couple of years. Moreover, ahead of the end of the first semester US dollar demand traditionally tends to rise for dividend payments.

Lastly, political uncertainty in Indonesia has had a negative impact on the rupiah rate. The market clearly supports Jakarta Governor Joko ‘Jokowi’ Widodo to become the next president of Indonesia. However, his rival - Prabowo Subianto - has narrowed the gap with Jokowi according to recent popularity polls/surveys and Indonesian media. As such, foreign market participants would prefer to wait and see for the election result first. On 9 July 2014, the Indonesian people will vote for their next leader.

Governor of Indonesia’s central bank (Bank Indonesia) Agus Martowardojo confirmed that the rupiah is facing a difficult time due to foreign and domestic troubles. However, he believes that the recent depreciating trend of the currency is only of a temporary nature as the economic fundamentals of Indonesia are strong (albeit always need improvement). Therefore, the central bank will not intervene in the money market to combat further depreciation (yet) although it does advise companies, whether privately-held or state-owned enterprises (SOEs) to wait with searching (unhedged) foreign loans. Bank Indonesia’s Executive Director Tirta Segara added that this year so far (January-June 2014), about USD $12 billion worth of foreign funds entered Indonesia, thus forming evidence of foreign investors’ confidence in Indonesia’s economic fundamentals.

Although the rupiah clearly has to face a difficult context at the moment, today’s performance was good. After the Federal Reserve announced that it cut its forecast for US economic growth and will continue to keep US interest rates near zero for a ‘considerable time’, emerging market currencies strengthened on Thursday (19/06). The Indonesian rupiah exchange rate appreciated 0.47 percent to IDR 11,940 by 15:05pm local Jakarta time according to the Bloomberg Dollar Index.

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 0.52 percent to IDR 11,916 against the US dollar on Thursday (19/06).

| Source: Bank Indonesia

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