Is Indonesian Rupiah (IDR) safe now?

We were panicked when our currency, Indonesian Rupiah (IDR), gradually depreciated and hit 30-month high at IDR13,780/USD on March 8. Indonesia, however, is not the only currency that suffers USD appreciation. As of March 23, IDR has depreciated 1.56% ytd against USD where Philippines Peso, Korean Won, Turkey Lira and India Rupee have depreciated around that level as well. Do we need to be worried for what’s happening in our market?

In the last two months, emerging markets have been unstable when huge capital started to pull out from emerging markets back to advanced economies. The Fed balance sheet normalization is the main driver which caused uncertainty in the market. If we look back to the end of 2017, Janet Yellen’s hawkish statement on Fed Fund Rate indicating three to four times hikes in 2018 confirmed investors and economists about stronger US economy.

How this interlinks with our market?

Since The Fed implemented quantitative easing to boost US growth after GFC, inflation has been used as an indicator to oversee the strengthening of US economy. Thereby, The Fed has also set the inflation target at 2%. In September 2017, US inflation surpassed The Fed target inflation for the second times after previously reaching the target in early 2017. During that time, US inflation has always been above the target with the latest inflation in February 2018 is 2.26%. Interestingly, based on data from US real sector, the US current expansion is now the third longest cycle since World War II which started in May 2009. And it will likely continue as the expansion has the slowest pace compared to other US expansions. It tells that the probability US be in a recession will not happen in near future. Furthermore, if US can keep this cycle throughout 2019, this cycle will be the longest expansion period that US will ever have.

Apart from US economy, economic growth from other advanced economies have persistently increased in the last two years which are reflected from the increase of inflation. In Europe, consumer confidence index has risen since the beginning of 2013. It happens in UK as well. Although UK economy is slowing down during Brexit transition period, UK inflation has risen recently justifying an improvement in demand side.

This kind of phenomenon has driven central banks of advanced economies, particularly The Fed, to consider leaving the expansion period and left the investors worried. Markets view the expansion policy of these central banks will end in near future as The Fed will be the first to do that. Based on Fed Reserve Statistics, The Fed has already started to reduce bond purchase in early 2015. Hence, The Fed’s balance sheet in February 2018 has shrunk around $75 bn in a year.

To respond this issue, global investors started to price-in The Fed’s policy by moving their funds from emerging markets to somewhere safe. Some say they are in “wait and see” mode because of this uncertainty.

Trump’s trade war

However, somehow, global markets have worsened when Trump imposed an increased tariffs on steel and aluminum on all US trading partners except Canada and Mexico in early March. China, EU and other countries responded to Trump’s action by stating that they would impose tariff on specific products to US as well. With this condition, markets read the response as a new chapter of trade war which eventually might wound the global economy. Hence, global market is in bad shape seen from the worsening stock and bonds markets, especially in emerging markets.

Meanwhile in Indonesia, as of March 23, stock market has significantly dropped 5.86% mtd and at the same time government yield 5-year has increased by 0.17 bps mtd. This deterioration in both markets are driven by nonresident investors who have pulled out their money in stock and government bonds by IDR12.5 trillion and IDR4.7 trillion respectively. This condition directly transmitted to money market because investors demanded USD when leaving our market. That is why our currency depreciates.

Fundamental aspects is not as bad as it seems

Indonesia fundamental aspects cannot be separated from this behavior issue. There are both downside and upside risk regarding this issue.

There are two downside risks that I think are quite disturbing. First, Indonesia’s current account has been deficit since Q4–2011 which burdens our balance of payments. We have been relying on trade balance to boost the current account. This dependence causes a higher deficit in current account whenever trade balance is in deficit. The government should consider to improve the services sector first as primary and secondary income will be harder to improve.

Second, our financial market has been shallow compared to other regional peers. High foreign ownership both in our stock and bond market poses higher risk in our market. With this condition, it is quite impossible to hold the market whenever nonresident investors are out of this country. That is why government should deepen the market by intensifying the financial inclusion and literacy as stated in FSAP recommendation as well.

What about the external debt? We can concern about the external debt that has risen from year to year, especially during Jokowi’s reign which focuses in infrastructure. But, this time is quite different from Asian Financial Crisis that happened twenty years ago. During the pre-crisis time, Indonesia external debt consisted mostly in short-term debt which was then used to infrastructure projects that has longer impact. But this time, Indonesia government has learned from that experience by allocating external debt in longer-term period which will avoid mismatch risk. The ratio of external debt to GDP is maintained around 30% and debt-to-service ratio is capped down around 25% in 2017.

The optimistic view comes from the demand side. People will likely to consume more in near future as Indonesia consumer confidence index has risen gradually since Q4–2015. Domestic corporate is still in “wait and see” mode to expand if the climate gets better as credit growth is relatively moderate recently. Meanwhile, inflation is successfully maintained in BI’s target range at 3.5% (± 1%) for the last 3 years.

Will IDR depreciate further?

In international economics, we know that currency depreciation drives exports higher. But somehow, if the currency depreciates beyond its value, it can hurt the exporters through currency mismatch. For instance, exporters borrow money in IDR for producing goods and will be paid in USD. Since IDR depreciates, exporters will earn less USD than it should while they produce same cost. It will then turn down the aggregate export.

We should thank that we have central bank that can maintain IDR to its fundamental value. To handle this issue, BI has intervened the currency market to maintain IDR. As a result, the external reserves decreased by USD3.9 billion in February 2018. It is quite safe as the external reserves just recorded an all-time high in January 2018.

But where IDR will go? I really do not know. Neither does the market. And even the central bank do not know either. Government and related authorities should play part in managing expectation so that they can lead us to avert something bad to happen.

The writer is a junior analyst at Indonesia Financial Services Authority. The views expressed are his own.