Analysis Global Market Volatility: Impact on Indonesia’s Rupiah

In a (seemingly) successful effort to avert a downward spiral, Indonesia’s central bank (Bank Indonesia) intervened by selling US dollars (implying that the country’s foreign exchange reserves - USD $111.1 billion at the end of November - shrink). Deputy Governor Perry Warjiyo said that Bank Indonesia also bought government bonds on the secondary market to support the currency. If pressures on the rupiah continue then the Indonesian government can also apply its stabilization protocol to support the rupiah (which involves rupiah-denominated bond buying on the secondary market by state-owned enterprises and the Finance Ministry) or through the multilateral currency swap arrangement (the USD $240 billion ‘Chiang Mai Initiative’).

Between 1 and 16 December 2014, international investors sold a net USD $960 million of rupiah-denominated sovereign bonds and USD $336 million of Indonesian stocks amid global uncertainty. Worldwide financial markets have showed significant volatility in the first two days of the week. This volatility is caused by several matters:

• The structural economic recovery of the USA implies further monetary tightening in the world’s largest economy. The Federal Reserve, which started its two-day policy meeting on Tuesday (16/12), is expected to announce higher US interest rates soon. Generally, it is believed that the institution will raise its key Fed Fund Rate somewhere in the first half of 2015. Similar to the tapering of the bond-buying program, higher US interest rates will trigger capital outflows from emerging markets. Those emerging markets that show financial weaknesses are particularly vulnerable to such outflows. A wide current account deficit (meaning that the country is dependent on foreign funding) is one of the indicators that are important to investors. By the year-end, Indonesia’s current account deficit is expected to have eased slightly to 3 percent of GDP. Although this performance constitutes an improvement from last year’s 3.3 percent of GDP, it is still a concern. On the other hand, a weaker rupiah should make Indonesia’s export products more competitive on the global market, while imports become more expensive. This should have a positive impact on the country’s trade balance.

Indonesia Current Account Deficit 2004-2013:

• Russia’s central bank caused a great volatility worldwide by raising its key interest rate from 10.5 percent to 17 percent on Monday (15/12) after the rouble suffered its worst fall since 1998 (depreciating nearly 10 percent). However, this did not stop the rouble from plunging further on Tuesday, intensifying concern that the country will default on its foreign debt obligations and enter a deep recession. Sharply falling oil prices and sanctions imposed by the international community due to the Ukraine-case have seriously affected the Russian economy.

• The preliminary index of Chinese purchasing managers (flash manufacturing purchasing managers’ index from HSBC Holdings Plc and Markit Economics) declined to 49.5 (indicating contraction for the first time since May). A slowdown in economic expansion of China (the world’s second-largest economy) hurts Indonesia as China is one of its most important trading partners. Slowing Chinese economic growth will put more downward pressure on commodity prices, implying that Indonesia’s export value (the country being a significant commodity exporter) will decline.

• Lastly, before the year-end, US dollar demand increases as local Indonesian companies need to settle debt repayments.

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 1.90 percent to IDR 12,720 per US dollar on Wednesday (17/12).

| Source: Bank Indonesia

In various media it has been discussed whether a similar scenario as in 1997 (the start of the Asian Financial Crisis) may occur in Southeast Asia. However - although there are a number of similarities (such as sharply falling global oil prices and weakening regional currencies) - there are important differences that make it highly unlikely for such a severe crisis to emerge today.

1. The financial crisis in 1997 turned into a political and social crisis in Indonesia as there was widespread opposition in society toward the corruption-ridden authoritarian system of President Suharto. Today, however, there is much more popular support for the Joko Widodo administration.

2. The financial sector, which was the heart of the crisis in 1997-1998, is currently much healthier, and more transparent than it was in the 1990s. Amid Suharto’s culture of patronage and corruption, the financial sector was not kept in balance through a supervision model, resulting in huge overseas short-term private debt. This proved to be a time bomb waiting to explode. Currently, Indonesia applies a system of prudent fiscal management monitored by institutions such as the central bank and the Financial Services Authority (OJK). The country’s external debt to GDP ratio is only about 27 percent, a low figure compared to developed and emerging countries. Furthermore, Indonesia’s foreign exchange reserves are now much stronger than in the 1990s.

3. Indonesia’s currency is not pegged to the US dollar (fixed exchange rate) anymore but floats (relatively) freely now, implying that depreciating pressures are instantly absorbed in the exchange rate rather than accumulating until the burden is too heavy to bear.

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