A Falling Rupiah Tests International Confidence in Domestic Reform Agenda

Bank Indonesia will raise its benchmark interest rate and flag more possible hikes as it escalates a battle to boost the fragile rupiah and contain capital outflows. (Photo courtesy of Investor Daily/David Gita Roza)

Jakarta/ Manila. The rupiah has been unable to escape pressure from global investors who move capital for higher yield in the United States.

While the currency is far from the worst performing one among other emerging market currencies, the onus is on the government to demonstrate a sustained commitment in structural reform to stem greater volatility in the currency and prevent it from wreaking further havoc on the economy.

The Indonesian currency has fallen 2.8 percent against the US dollar so far this year, and trading close to 14,000 against the greenback, a level the country last saw in 2015, amid a massive sell off in the stock market.

Foreign investors, who largely hold the most liquid stocks on the Indonesia Stock Exchange, have sold Rp 36 trillion ($2.6 billion) worth of stocks since January. That is just Rp 4 trillion short of all the shares they sold in all of last year.

Indonesia’s central bank, Bank Indonesia, has spent around $6 billion from foreign exchange reserves since January to defend the rupiah. While total reserves now stand at $126 billion, more than enough to cover six months’ imports, the central bank said that it could resort to tightening benchmark interest rates.

Still, global sentiments could only be a trigger for a more fundamental change in how investors perceive Indonesia, particularly in the way the government reforms its economy to ensure long-term growth.

In the past four years, the largest economy in Southeast Asia has won back coveted investment grade statuses after slashing fuel subsidies and pooling resources on infrastructure spending. President Joko “Jokowi” Widodo also introduced wide-ranging deregulation to encourage domestic and foreign investments.

However, in the last few months, Jokowi seems to have backtracked on some of his reforms. He introduced a two-year cap on fuel and electricity prices and put a lid on rice prices.

For holders of Pertamina’s or Perusahaan Listrik Negara’s bonds, the policy introduced more uncertainty and additional risks to their investments. Other investors have begun to wonder if the government might eventually exert control of companies whose stocks or bonds they hold.

“Foreign investors could be seeing this as no-hope for further reform. Looking at the [more favorable] United States, they would prefer to leave Indonesia. The market is very concerned about any price control, because they have bad experiences with Venezuela and Easterb Europe,” former minister Chatib Basri said in recent interview with financial newspaper Kontan.

With the current account deficit expected to widen to 2.0-2.5 percent of gross domestic product this year, and the state budget deficit at 2.2 percent of GDP, Indonesia can not afford to lose more investor confidence.

“During times like this, apart from BI doing stabilization efforts, the most important thing is for the government to clearly convey that it will continue its structural reforms, the real economy,” said Mirza Adityaswara, senior deputy governor of Bank Indonesia.

The reform includes deregulation in sectors that produce goods for exports, tourism, lending and foreign investments, among others, Mirza said.

“Structural reform is not easy and cannot be done in a short period, but that’s the only way to mitigate shocks like this,” Mirza said at the sidelines of the Asian Development Bank meeting in Manila last week.

Brace for Impact

For now, businesses are bracing for the impacts of a weaker rupiah, relying on domestic suppliers, reserve stocks or delayed payments to avoid increasing prices for consumers.

Astra International, Indonesia’s largest automotive distributor, sees price increases as inevitable if the rupiah continues to weaken against the US dollar.

“If rupiah continues to weaken, the car prices will be raised, for example by 2 percent,” Henry Tanoto, director of Astra International, said. “We try to withstand [the weakening] for now, because if today we increase the prices, it is unlikely we will lower them again the future,” Henry said.

Astra sources more components from local producers to shield it from volatility in import prices. Today, 95 percent and 90 percent of the motorcycles and cars the company produces are sourced locally, respectively.

Processed food and beverage producers said that their current contracts with foreign suppliers may spare them from having to increase prices, at least until after Idul Fitri, which falls on June 14.

“The industry has reserve stocks for its raw materials that usually last for about a month, and we also have stock for finished materials for about two weeks to a month … But we hope the exchange rate will not reach Rp 14,000, as it will be a critical point for us,” said Adhi Lukman, chairman of the Indonesian Food and Beverage Association (GAPPMI).

Fresh fruit and vegetable importers however are less fortunate, facing a potential Rp 2.5 million loss per day on every container shipment they make should the rupiah depreciate by 100 against the US dollar, said Khafid Sirotuddin, chairman of the Indonesian Fresh Vegetables and Fruits Exporters-Importers Association.

Josua Pardede, an economist at Bank Permata, predicts that the rupiah will soon normalize.

In the short term, the central bank’s role will be substantial in keeping the rupiah exchange rate from falling in the financial market, which can be done through raising interest rates.

Bank Indonesia can also multiply trade agreements with local currencies of other countries to reduce the dependence of exporters and importers on the US dollar in trade transactions.

“If the dependence on the dollar declines, the rupiah will eventually be more stable,” Josua said.

Josua added that in the second half of the year, the rupiah will have a chance to strengthen. In June, the signal of the Fed funds rate increase will be clearer and the market’s sentiment will subside.

Reform Continues

Finance Minister Sri Mulyani Indrawati said the government would continue to ensure that fiscal policy will be inline with its reform commitments.

“What I always communicate is that while the state budget will continue to support [the government’s] development agenda, the budget needs to be stronger because shocks from regional and global economies will only intensify,” Sri Mulyani said.

“We can see the shocks today, like President Donald Trump’s trade war with China, or [the steep increase of] oil price.”

Sri Mulyani said the government is working towards a stronger fiscal policy by increasing revenue, controlling its spending and managing debt prudently.

The government broadened its tax base from the tax amnesty policy it introduced last year. The country is also working on increasing revenue from deposits of natural resources as lawmakers discuss a new bill on non-tax revenue, which will allow the country to get fairer royalties from the sales of those resources.

“This way we can accumulate what I called ammunition to face the shocks,” the minister said.

The government has stated that all of its spending is intended to “protect the poor, drive economic growth and lay down the foundation for the economy to grow even higher in the future.”

Writing by Dion Bisara, additional reporting by Amal Ganesha in Manila for Jakarta Globe