Indonesia Struggles to Strengthen Weakening Rupiah

By Edward Barbour-Lacey

Tuesday, March 17^th, Indonesia’s central bank, Bank Indonesia, announced that it will hold the country’s key interest rate steady at 7.5 percent. The bank has chosen not to follow the recent regional trend of countries drastically cutting their borrowing costs.  Markets have so far met the news positively and the rupiah has strengthened 0.6 percent to 13,165 against the dollar – the largest gain in eight weeks. Indonesia’s government has been struggling to strengthen a rapidly weakening rupiah, the country’s currency. The rupiah is Asia’s worse performing currency against the U.S. dollar this year.

The recent move to hold the interest rate steady, according to Bank Indonesia spokesman Tirta Segara, was to “keep inflation in check and rein in a stubborn current-account deficit”. Inflation in Indonesia has been slowing in recent months, but is still above government targets.

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In January, the country’s central bank surprised investors by implementing a 25 basis point cut in its interest rate – this was the first reduction in the rate in over three years. However, this move was not met happily by investors and the rupiah declined to its lowest level in 17 years – a level not seen since the Asian financial crisis.

The rupiah has declined six percent this year, and two percent in just the last week. The currency has also been weakened by Indonesia’s large current account deficit.  Country’s such as China, Thailand, and South Korea have all instituted interest rate cuts this year.

Bank Indonesia has had to balance its decision-making against the knowledge that it may trigger large capital outflows from the country if it cuts its interest rate.  The February rate cut caused significant outflows from the country, which, in turn, caused further weakening of the rupiah.  Over 40 percent of outstanding rupiah-currency bonds are owned by foreigners, who have poured money into Indonesia in recent years in a search for higher yields. These issues have been compounded by the fact that the United States will likely raise short-term interest rates soon and thus encourage capital to move away from countries like Indonesia.

Despite its recent decision to hold the interest rate steady, many analysts believe that Indonesia will soon be forced into making another rate cut in order to keep the country’s growth rate at target levels – the government has set a GDP growth target of 5.7 percent for 2015. This target growth rate may be overly optimistic according to many analysts; however, the weakening rupiah may help make Indonesia’s exports more competitive and help balance its current account deficit.

Indonesia’s economy is primarily export driven. Exports have declined 16 percent year on year; however, trade appears to have picked up as a result of the weakened currency. Despite some positive signs, the government is still predicting the current account to post a deficit of three percent of GDP. Not helping the matter, foreign companies are repatriating their profits at much higher levels due to their fears surrounding the volatility of the rupiah.

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In order to stop the flow of capital out of the country and stabilize the rupiah, Indonesia is considering a range of options, such as tax incentives and anti-dumping import duties. In particular, the government will be revising corporate tax allowances and holidays in order to attract additional investment; this will include tax breaks for companies that reinvest their profits back into the country.

Indonesia’s central bank has pledged to intervene further in the economy if more action is needed to stabilize the rupiah and government bonds.  The bank has also stated that it will work to keep the currency in line with fundamentals and attempt to rein in inflation. 

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