The Indonesian rupiah slumped for most of 2018, but with the currency enjoying a comeback against key global currencies such as the US dollar in early 2019, the authorities appear to have warded off a major threat to growth. The policy decisions of 2018, including monetary policy and import replacement, affirmed a sense of long-term economic progress in the country.
Indonesia’s currency pressure came to a head in October 2018 when the rupiah fell to a 20-year low to rates last seen during the Asian financial crisis of 1997-98. The depreciation was largely due to a strong US dollar as well as the US Federal Reserve’s four increases to benchmark lending rates in 2018. When the US boosts rates, repercussions are felt in bond markets worldwide as higher rates make US government debt more attractive in comparison to that of other countries. If other central banks keep their rates the same, bond investors could sell locally and buy in the US, causing capital to leave the country and lowering the value of the local currency. In hopes of avoiding this, emerging market central banks such as Bank Indonesia (BI) often choose to respond to US Federal Reserve rate increases with reciprocal hikes at home. BI increased the lending rate six times in 2018, pushing it 1.75 percentage points higher to 6%. In doing so Indonesia preserved capital inflows and avoided the capital flight seen in 1997.
Twin Deficits
Indonesia may have felt currency pressure more acutely than other emerging economies due to a budget deficit of 1.8% of GDP in 2018 and a reliance on imported consumer goods that resulted in a current account deficit of $31.1bn, or 3% of GDP, according to figures from BI. With twin deficits – budget and current account – weighing on the economy, the currency depreciated. In late August 2018 the currencies of two other countries with twin deficits, Argentina and Turkey, crashed as investors worldwide sold off emerging market assets in favour of those in the US. While the rupiah fell, it did not crash as it had in Argentina and Turkey, as sound policy making fostered more stable economic fundamentals. After credit ratings agency Fitch conducted stress tests in key emerging markets in July 2018, it found no broad risks in Indonesia. “This is the result of a disciplined monetary policy stance and macroprudential measures that have helped curb a sharp rise in corporate external debt,” the ratings agency concluded. Highlighting Indonesia’s strengthened position, Fitch as well as the two other ratings agencies, Standard & Poor’s and Moody’s, rated Indonesia’s debt as investment grade, a marked improvement from the “junk” status it had in 1998. Foreign reserves held by BI were at about $123.3bn in February 2019, compared with $24bn in 1998. “We believe Indonesia is much stronger today when compared to 1998,” Charu Chanana, deputy head of Asia research at Continuum Economics in Singapore, told media.
In April 2018 Moody’s upgraded Indonesia’s sovereign rating to “Baa2” with a stable outlook, months after Fitch also upgraded the country. Moody’s noted the government’s credible and effective policy framework had created an environment conducive to macroeconomic stability. Ratings agencies also noted stability in the country’s state-owned enterprises: Standard & Poor’s upgraded the credit rating of Perusahaan Listrik Negara (PLN), the state-owned enterprise that distributes and generates electricity, in August 2018. The following month PLN sold $2bn in bonds with the guidance of the Ministry of Finance (MoF). The cost of the funds, however, was an indication of the challenging market as investors demanded an interest rate one percentage point higher than that of the federal government, compared to a premium of less than 0.5 points for previous sales. The trade-off for hiking rates and preserving demand for bonds was reduced buying power for imports. The economic leadership managed to spare consumers somewhat, as inflation remained below 3.5% and well within the BI’s target range of 2.5-4.5%. However, the diminished ability to import took a toll on the country’s infrastructure drive. PLN announced a delay to its plan to build more power plants (see Energy & Mineral Resources chapter). The postponement of $23.9bn in capital expenditure on new power plants represented 15,200 MW of planned capacity, about 43% of the total. The weaker rupiah made imported equipment more expensive, and local content in the projects made up between 20% and 39% of the total.
Intra-Agency Collaboration
Efforts of the MoF to stabilise the economy boosted the confidence of investors and ratings agencies. Even though Indonesia produces significant amounts of oil and gas and is a member of the Organisation of the Petroleum Exporting Countries, it remains a net importer of fuel due to growing domestic demand and maturing oil reserves. Fuel imports became increasingly expensive as oil is mostly traded in US dollars and a drop in an importer’s local currency makes energy costlier. The government has therefore implemented additional regulations in the energy sector to guard against inflation. In September 2018 it mandated the use of biofuels to lower imports of gasoil, the category of refined fuels that includes jet fuels and automotive diesel.
Biofuel is an attractive alternative to imported fuels as Indonesia is the world’s largest exporter of crude palm oil, accounting for 55% of international sales. Compulsory biofuel use built on previous regulations that mandated a 20% biofuel blend. Indonesia allocated 1.4bn litres of biodiesel for blending from November 2017 to April 2018, and the figure increased to 2bn litres between May and December 2018. In November 2018 the government announced an expansion of the plan, and an allocation of 6.2bn litres for 2019. In December the Ministry of Energy and Mineral Resources said it was conducting technical studies to determine if vehicles and machinery could be powered by fuels using 30% biodiesel or even by biodiesel alone.
Silver Lining
In addition to reining in state-owned enterprise spending and energy costs, Indonesia hoped to spin the currency woes into a positive for foreign investors by emphasising opportunity in the financial services sector. The country is working to attract foreign investors to buy licensed banks and insurers in Indonesia and merge them, in the hope of creating a consolidated financial sector with fewer players and larger balance sheets. In September 2018 Fauzi Ichsan, head of the Indonesia Deposit Insurance Corporation, suggested that the current conditions would make these acquisitions cheaper. “Consolidation will be good and with a weakening rupiah it would be cheaper for global investors to buy our banks,” Ichsan told local media. Rino Donosepoetro, CEO of Standard Chartered Indonesia, affirmed this view. “Banking consolidation is happening as a number of local banks try to get foreign partners. Yet, a foreign bank consolidating with domestic banks is more frequent than domestic consolidation. This occurs more for the purpose of foreign banks to enter the Indonesian market,” he told OBG.
Bouncing Bank
In October 2018 the rupiah hit a 20-year low of Rp15,233:$1 before beginning a rally that had gained back 8% of the loss as of March 2019. The recovery was ongoing in early 2019. Inflation remained within BI’s target range and capital inflows increased. However, the current account deficit widened, from $1.1bn in December 2018 to $1.3bn in January 2019, due to falling coal prices. “Although capital inflows have increased since October 2018, the weakening of foreign trade flows has not yet subsided,” research from the Institute for Economic and Social Research, part of the University of Indonesia’s Faculty of Economics and Business, found in February 2019. While the pressure on the currency eased in early 2019, some observers are leaning on BI to reverse monetary policy and lower rates to boost economic activity and allow businesses to pay less for expansionary activity. Despite this, BI is expected to maintain a tight approach and investors have reacted favourably. “In 2019 we expect accelerated GDP growth, a less volatile rupiah outlook, solid earnings growth and reasonable valuation supported by multi-year lows in foreign investors’ positioning,” Japanese investment bank Nomura Securities wrote in December 2018.
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