Indonesia is the emerging market most vulnerable to the consequences of the US Federal Reserves tapering of quantitative easing and to Chinas economic slowdown, according to economists.
"Indonesia has been hit on both sides [by the Fed and China]," says Gareth Leather, Asia economist at Capital Economics.
In May, the Fed announced it would scale back its $85 billion bond-buying plan, putting emerging markets into a tailspin. Quantitative easing in the US encouraged investors to turn to emerging markets in a search for better earnings, but with the Fed move, yields in countries including Indonesia have started to rise from all-time lows.
At the same time, Chinas economic slowdown has affected Indonesias export market as the demand for commodities has decreased, putting downward pressure on oil and gas prices.
As a result, Indonesias strong fundamentals exemplified by the countrys promotion to investment grade last year have come into question and its potential frailties have been exposed.
Early in July, Indonesia sold $1 billion in dollar-denominated bonds at a yield of 5.45%, the highest yield since 2010 when the country sold a 10-year note at 6%. On July 16, 10-year bond yields rose to 8.3%.
|Enrico Tanuwidjaja, southeast Asia economist at Royal Bank of Scotland|
Policymakers have increased benchmark interest rates by 75 basis points since June and reduced fuel subsidies for the first time since 2008, effectively raising petrol prices by 44% and diesel prices by 22%.
But despite the measures, outflows continue as investors become increasingly risk-off. Triggered by a strengthening US economy, the rupiah has continued to weaken, sliding 1.3% to 10,200 to the dollar the weakest rate since July 2009.
The latest policy moves have failed to curb Indonesias current account deficit, which continues to widen. "The persistency of the current account deficit in Indonesia is the most worrying," says Tanuwidjaja.
Shweta Singh, economist at Lombard Street Research in London, says: "Fed tapering has become one of the predominant concerns; those countries with current account deficits are first in line to suffer the most."
Indonesia imports many of the capital goods needed for growth, but export proceeds needed to pay for these have continued to fall as commodity prices have struggled over the past year, adding to six straight quarters with a current account deficit.
According to national statistics, Indonesia exported $14.7 billion of goods in April, down 9.1% on the previous year and 2.2% on a month earlier. And although southeast Asias largest economy has recorded growth of more than 6% in four of the past five years, signs have emerged recently that growth is slowing, in part because of falling demand in China.
The economic slowdown in China has exacerbated the problems faced by Indonesias economy and intensified the current account deficit.
"A significant proportion of Indonesias current account balance depends on commodities, and that is the countrys key growth driver," says Singh. "We dont see growth from commodities coming back strongly because we dont see Chinas growth recovering to the levels we saw in 2009 to 2011."
Official government forecasts place Chinas GDP growth for 2013 at 7.5% a lacklustre rate for the previously high-flying economy although a recent statement by Chinese finance minister Lou Jiwei caused a stir, announcing that GDP growth would be around the 7% mark. On the back of this, some analysts have slashed GDP growth forecasts for China in 2014 to below 7%.
China is entering an extended phase of slower growth. It might be that Indonesia will experience a structural rather than just a cyclical current account deficit, says Singh.
Tanuwidjaja says: "Problems with the current account are a lot more persistent in Indonesia because investment spending is not good".
According to the Investment Coordinating Board in Indonesia, total investment climbed 29.8% to Rp99.8 trillion ($9.8 billion) in the second quarter this year from a year earlier. In the first six months of 2013, investment rose 30.2% to Rp192.8 trillion from a year earlier. Foreign direct investment is expected to slow because of the global investment environment.
At the same time, Indonesia does need to reduce its vulnerability to external financing conditions in the face of diminishing support from commodities. "The ideal path would be to keep a tab on domestic consumption, deepen capital markets, whilst providing the regulatory framework to increase investments domestic and external and raise productivity in the non-commodity sectors," says Singh.