As Asian nations explore the risks and opportunities presented by tumbling energy prices and the rising US dollar, policy makers across the region face a balancing act — none more so than in Indonesia.
Falling inflation has given several central banks the confidence to lower interest rates in an effort to spur growth. South Korea cut its benchmark rate to a low of 1.75 per cent in March, joining China, India and Thailand in Asia’s loosening club.
High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights. http://www.ft.com/cms/s/0/afdafa84-d431-11e4-b041-00144feab7de.html#ixzz3WkQ4aW3C
Bank Indonesia is in a particular bind. Its decision to cut rates in February has pushed the rupiah to its weakest since the Asian financial crisis and once again exposed the risks of capital flight for an economy still reliant on foreign inflows to balance the books.
“We still have a problem with the current account deficit so the central bank must be very prudent,” says David Sumual, chief economist of Bank Central Asia. “We are still too dependent on portfolio investment.”
President Joko Widodo arrived in office in October in time to see growth in 2014 slow to a five-year low of 5 per cent amid expectations of lower inflation and higher US interest rates.
Indonesia’s central bank began the year indicating it was relaxed about taking the rupiah into a controlled descent against the dollar to reduce the country’s current account deficit, which was 2.95 per cent of gross domestic product in 2014.
Policy makers hope a lower rupiah can encourage Indonesian exports and so trim the shortfall. However, the speed of the rupiah’s fall has surprised many, while currency weakness across the region has dulled its benefits.
“Competing on price won’t get you very far because other Asian economies are playing the same game,” says Wellian Wiranto, economist at Oversea-Chinese Banking Corp. “They are all trying to keep their currencies fairly weak.”
The central bank has now been forced to change tack, saying in March that it would “beef up” efforts to defend the rupiah and intervene in the market when necessary.
For now, it has just enough firepower to do so. Indonesia’s foreign reserves stand at $115bn — at 13 per cent of gross domestic product, the lowest in the Association of Southeast Asian Nations — but analysts say reserves can drop to about $100bn before jitters set in. Anything lower than that is likely to present a tough choice for the authorities.
“If they have insufficient funds for the current account then they will have to decide whether they want to support the currency or do something else,” says Irene Cheung, Asia foreign exchange strategist at ANZ Bank. “If the currency comes under pressure they will either have to support the currency by official intervention or they will have to let the currency go.”
There has been some movement in the right direction. The government announced measures in March designed to raise foreign exchange receipts, including anti-dumping measures and tax breaks for investors that reinvest dividends in the country.
Indonesia also reported small trade surpluses in January and February. But economists warn this could come under pressure in the second half of the year as planned infrastructure spending drives up imports of machinery and equipment — just as the US Federal Reserve is expected to begin tightening.
“The market has dialled down the expectation of a Fed rate hike, but nonetheless it is probably the biggest risk this year,” says Mr Wiranto.
Indonesian companies held $162bn of external debt as of January, according to Bank Indonesia. The poultry and retail sectors are struggling, while plantation and textile companies are benefiting from the currency strategy.
However, aggregate dollar debt among Indonesian companies remains relatively low, analysts say, and Bank Indonesia is pressing companies to hedge their foreign exchange exposure by introducing fresh guidelines.
“Indonesian companies are much less vulnerable to external borrowing than is the general perception,” says Ferry Wong, Citigroup analyst.
original source: http://www.ft.com/cms/s/0/afdafa84-d431-11e4-b041-00144feab7de.html#axzz3WkO069Uw