With the recent plunge of the Indonesian rupiah from one of Asia’s best-performing currencies to one of its worst, many fear that the specter of the 1997 Asian financial crisis has returned to haunt the archipelago’s sandy beaches. At present, the Indonesian rupiah (IDR) trades at roughly 13,000 to one U.S. dollar (USD), its weakest level since 1998. The ongoing currency depreciation may pose the greatest threat to Indonesia’s economy in more than a decade unless the government acts decisively to rectify the situation.
For this reason, President Joko Widodo, commonly called Jokowi, must prioritize the stabilization of Indonesia’s weakening rupiah if Southeast Asia’s largest economy is to sustain its rapid growth. A failure by the president to demonstrate strong economic leadership would undermine his credibility and have a chilling effect for commercial activity in the region.
While rarely the focal point of the global economy, the Indonesian rupiah, the legal tender of Indonesia and its 250 million citizens, is historically one of Asia’s highest-yielding currencies. However, its openness to foreign capital flows has backfired in the past, most notoriously during the 1997 Asian financial crisis – a watershed event resulting in the removal of the president, the independence of East Timor, and riots in the street of Jakarta.
Today, the ailing Indonesian rupiah is unlikely to find much assistance from the global economy, as the US recovery reduces the investment appeal of emerging markets, and ongoing weaknesses in Japan, China, and Europe damage the market for exports. Consequently, the economic community must look to Widodo and Bank Indonesia (BI), the country’s central bank, to stabilize the situation in response to both foreign and domestic factors.
Internationally, the dollar continues to strengthen as the United States economy recovers and the U.S. Federal Reserve indicates it may shortly raise interest rates, pulling capital away from emerging markets and weakening regional currencies.
However, while the rise of the dollar has had implications for the entire region, the rupiah’s fall has been the steepest in Southeast Asia because of domestic considerations. The Jokowi administration’s decision to sharply reduce the Indonesian fuel subsidy at the end of 2014 and general dollar/rupiah illiquidity within the domestic foreign exchange market both exacerbated market volatility.
First, the removal of the fuel-price subsidy, while freeing up over one hundred trillion rupiah in government spending, induced confusion among market participants. The resulting fuel price-hike triggered an increase in inflation and a reduction in Indonesian rupiah bond prices – forcing the market to cut losses on long-term bonds, or worse, choose to engage in capital flight. As foreign investors hold roughly 38 percent of current rupiah-denominated bonds, Jakarta must do everything it can to keep market sentiment under control.
The current lack of liquidity within the Indonesian financial market complicates the issue. The impact would not be as steep were Indonesian exporters to place their revenue within the country’s banking system, but between the lure of the adjacent Singaporean financial community and the small domestic spot market for small-sum dollar/rupiah conversions, little incentivizes them to stay.
Jokowi would be well served to take the weakening rupiah as a signal to pursue economic reform while protecting the country’s competitive edge in international markets. The subsidy reduction, combined with government revenues from oil and gas exports, provides Jokowi with political capital, and as such he should press his advantage by pursuing several policies to shore up the rupiah and demonstrate economic leadership in tandem with Bank Indonesia.
Jokowi’s immediate goal must be to take action to narrow the current-account deficit, which has worried foreign investors for years. One straightforward means of doing this would be to enforce a 2011 law requiring all parties’ transactions within Indonesia to be conducted using IDR. Many companies, especially in export-oriented industries, have been reluctant to follow the regulation as dollar-denominated revenues effectively hedge against rupiah depreciation. The rupiah transaction rules, long neglected, should be implemented as soon as possible as a means of increasing the foreign currency reserve and demonstrating the administration’s tight monetary stance.
Moreover, Jokowi must coordinate with Bank Indonesia to convince market makers of the rupiah’s integrity through judicious implementation of economic and monetary policies. In the short term, this involves signaling to observers that BI has the ability to fund Indonesia’s current account deficit and is capable of intervention if the rupiah weakens too much. The ultimate objective must be to improve the country’s trade balance and contain the impact of the current-account deficit, currently at roughly three percent of gross domestic product (GDP), on the developing economy.
This effort must be carefully harmonized between both players. Without communication, the danger remains that Bank Indonesia may overextend attempting to defend the IDR from foreign exchange and deplete its currency reserves. With confidence and trust the keys to stability, BI must avoid doing anything that might signal to market participants it is not in control. Allowing rampant debasement of the rupiah due to negative market opinion will produce an economic crisis spurred onwards by spiraling inflation and reduced purchasing power, with the ultimate outcome of increased absolute poverty.
For this reason, trade competitiveness must be balanced with financial stability. The administration and the central bank must work together to ensure that the burden of economic structural deficiencies do not weigh too heavily on either the shoulders of the Indonesian people or foreign investors in Indonesian equities.
Jokowi’s efforts to curb the central government’s budget have been commendable, especially on hot-button issues that once seemed untouchable – like fuel price policy reform. Now, as Indonesia faces its worst currency crisis in 17 years, the president must exercise strong monetary policy acumen, working in tandem with Bank Indonesia to stop the fall of the rupiah. With a combination of sound macroeconomic management, a steady policy climate, and concerted government efforts to bolster market institutions and infrastructure, the Republic of Indonesia will weather the storm currency fluctuations have brought upon its shores.
original source: http://thediplomat.com/2015/04/jokowi-must-confront-a-weakening-rupiah/