economy slowing, monetary policy in Indonesia is becoming
tangled in a trap that echoes the dark days of the Asian
financial crisis in early 1998, when Indonesian policymakers
faced a stark choice: the economy or the currency.
as it is, even depreciation – the IMF’s
standard prescription to ward off a balance-of-payments crisis
due to its effect of making exports cheaper and imports more
expensive – isn’t working.
rupiah has lost more than 11% of its value since July,
India as the emerging markets’ (EMs)
worst-performing currency, but has stabilized of late,
recovering in recent trade to 11,203 to the dollar.
more, consumer price inflation has doubled this year to a
four-year high of 8.8%, with analysts predicting it could hit
double digits, despite the central bank hiking interest rates
twice in the past month.
Fed-tapering panic erupted in May, the country was able to
finance its current-account deficit despite rising imports and
falling commodities export prices, thanks to capital inflows
chasing higher real rates in Indonesia.
that support from external liquidity conditions has dried up,
placing the capital and financial account balance under
pressure, forcing Indonesia to dip into its foreign-exchange
reserves to fund the deficit and support the
EMs, Indonesia is one of the most exposed to short-term
external funding risks because it has a smaller
foreign-exchange war chest.
foreign-exchange reserves – which have dropped 17.5%
this year from $112.8 billion to $93 billion – are now
sufficient to cover just five months’ imports and
external debt payments.
IMF, however, recently cut its 2013 growth forecast for
Indonesia to 5.25% from 6.3% and raised its current-account
deficit forecast to 3.5% of GDP.
inflation compared to the rest of the world means that although
the rupiah has come off a lot against the dollar on nominal
basis, on a real effective exchange rate it has actually
appreciated over the last two months, says Shweta Singh, EM
economist at Lombard Street Research.
competitive advantage that the weaker rupiah should give to
Indonesia is not coming through because inflation is so
has benefited tremendously from easy external liquidity
conditions, which helped support domestic demand thereby
worsening the current-account deficit. This deficit is
difficult to adjust because imports are quite inelastic and
exports are prone to downside risks to commodities prices from
imports have a lot of subsidy support, so even if they come
down on domestic demand it may not necessarily impact imports
overall because import oil demand is not
says rates will have to be raised a lot more to push down the
non-oil component of imports sufficiently to compensate for oil
imports than if oil was not so heavily subsidized.
the central bank will have to continue raising rates to keep
the real interest rate elevated to bring down domestic demand
and moderate its impact on the current-account deficit. That
will have ripple effects on domestic demand growth feeding into
real GDP growth.
common with other EMs, Indonesia’s appetite for
tackling the structural reforms it neglected during the good
times is being tested given the pressure on living standards
and a presidential election next year.
government has been behind the curve, putting off fuel price
rises until June when its hand was forced by a sell-off in
equities and government bonds, and deteriorating economic
Bank Indonesia has been slow to react to rising inflation and
the sell-off sparked by Fed-tapering fears, holding rates at
its August 15 meeting only to raise them at an emergency
meeting two weeks later. As recently as last year when the
economy was in danger of overheating, it was still cutting
see the situation as far less ominous, arguing the high
inflation rate is a temporary spike and that
Indonesia’s fundamentals and potential make it
well placed to benefit from stronger global growth.
it hasn’t been a good year for
says Gareth Leather, Asia economist at Capital
is very high, the balance of payments has deteriorated and the
currency has fallen quite sharply this year.
a crisis is still some way off, especially if you compare the
situation to what it looked like on the eve of the Asian
financial crisis. Inflation is very high but it’s
pretty much entirely due to the government’s
decision in June to slash fuel price subsidies, which has
pushed up transport costs.
inflation is much lower than the headline figure and this oil
element will work its way out over the coming months so
inflation should come down next year.