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Mystery of the weakening rupiah

Publication Date : 17-08-2012


Indonesia, currently one of the fastest growing economies in Asia, has seen its currency weaken significantly this year. And most analysts expect the rupiah to fall even further in the coming months. Why should this be so?

"It is confusing," admitted Purbaya Yudhi Sadewa, chief economist of Danareksa Securities, when The Straits Times spoke to him in Jakarta last week. "The Indonesian economy is looking good for the next five years."

Some foreign investors, it seems, are nevertheless pulling out of the local capital market and investing in dollar-denominated assets. Indonesian bonds were the worst performers in Asia in the first half of this year.

The uncertain road to economic recovery has sapped business confidence in major markets across the globe in recent months. The growing pessimism has been fuelled by China's slowing economy and the inability of European leaders to find a way out of the continent's debt crisis.

Indonesia's relatively low export to gross domestic product (GDP) ratio, however, has meant that the economy as a whole has remained largely unaffected by the global downturn. In the second quarter of this year, GDP grew by an unexpectedly strong 6.4 per cent, making Indonesia one of the best performing economies in Asia outside China.

Despite this, the rupiah has been weakening since September last year, when the exchange rate to the greenback stood at 8,500. In more recent weeks, the currency has stabilised at around the 9,500 mark, but only after determined market interventions by Bank Indonesia (the central bank).

"The stock market is weaker than the economic fundamentals would suggest," notes Purbaya, adding that the attitude of many investors in the capital market is that in times of global uncertainty, developing economies are riskier.

But this cannot explain everything. Following regional trends, the Jakarta Composite Index is up about 8 per cent this year. This may sound like a good thing, but it is well below the stock market performances of slower growing economies such as Thailand (stock market up 18.5 per cent), the Philippines (20.3 per cent) and Singapore (15.4 per cent).

Only in Malaysia, where political factors continue to weigh heavily on investor sentiment, has stock market performance been worse. The Malaysian bourse has risen by just 7.5 per cent so far this year on the back of an estimated second-quarter GDP growth of 5 per cent.

One possible explanation is that capital market investors have yet to fully trust Indonesian regulators. Another - more likely reason - is that Indonesia's strong performance relative to its Southeast Asian neighbours since 2009 has meant that investors see more upside potential in neighbouring countries.

Admittedly, Indonesia's widening current account deficit is at least partly to blame for the weakening currency. Indonesia posted a trade deficit of US$1.3 billion in June, following shortfalls of $207 million in May and $765 million in April. The trade deficit in June was the largest in five years.

But while the trade deficit has contributed to the rupiah's weakness, it is almost certainly not the primary cause. This is because the rupiah began weakening in September last year, when the trade balance was still in positive territory.

Meanwhile, foreigners with much longer investment horizons are pouring in.

Despite high global uncertainty, realised foreign direct investment (FDI) in Indonesia has been rising steadily in recent years. From a mere $2.8 billion in the first quarter of 2009, FDI inflows reached an all-time high of $6.2 billion in the second quarter of this year.

The resulting surge in the import of capital goods is the main reason for increased trade deficit. This situation should begin to turn around later this year as the companies concerned begin production.

And it is developments such as these, together with strong domestic consumption and continued FDI inflows, that are likely to remain the main drivers of economic growth for the remainder of this year and throughout next year.

Such developments will inevitably have an impact on the local capital market. Indeed, the more stable rupiah following market intervention by Bank Indonesia is already helping to revive interest in the country's bond market. According to an index prepared by HSBC Global Asset Management, local-currency notes have gained 4.1 per cent since June 30. Their average yield of 6.2 per cent is now the highest in South-east Asia.

Indeed, the capital market investors who left the country earlier this year now seem far too myopic. Perhaps the real puzzle is why they left in the first place.


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