Is there any hope for the
local currency?


The Indonesian currency continues to weaken amid ongoing global economic turmoil. Can we expect a turn-around anytime soon?

During the start of the year, many economists, including ourselves, were optimistic that the rupiah had room to regain lost ground in terms of its value against the dollar.

From a trade perspective, it didn't - and it still doesn't - look like Indonesia was in much danger. Exports are expected to drop, but so are imports from the rest of the world. With the commodity bubble having burst, there will definitely be less need to import trucks and heavy equipment to use in mines and plantations. There will also be less need to import cars as firms and households cut expenditure budgets.

One need not look very far for examples. Neighbors Vietnam and Philippines have already experienced an improvement in their trade deficits in recent months, as imports dropped faster than exports. It is likely that Indonesia will follow suit - although the December 2008 trade figures still show a slight deterioration in the balance of trade.

What puzzles many is that the rupiah keeps on sliding against the dollar from one day to the next. From Rp10,950 a dollar at the start of the year, the local currency is currently close to 11,800, or down by around 8 percent year to date.

Judging from the foreign holdings in the bond and money markets, there appears to have been a small but steady stream of capital outflows since the beginning of the year.

Many have been attributing this to fear over the unwinding of reported derivative transactions which may have soured. And some are worried about pressure from private sector short term external debt repayments. The government has even publicly urged the central bank to guard the rupiah at its "equilibrium" level; i.e. assuming one ever existed.

These domestic-related concerns are not groundless. But from a broader perspective, we should also take note that the rupiah is not the only currency that's been doing badly. Judging from the trade-weighted US dollar index - which measures the performance of the dollar against major currencies - other currencies have also weakened against the dollar, although by a slightly lower average magnitude of five percent this year to date.

So despite the existence of some country-specific risks, external factors appear to be playing a key role in determining the exchange rate nowadays. In such an environment, forecasting the IDR/USD based on domestic fundamentals alone entails a larger risk of error.

This is not to say that domestic fundamentals don't matter. Trade positions are important; however abrupt changes in market sentiment make capital flows hard to predict, and this has been the source of instability. For example, an improvement in Indonesia's trade position won't do much good in propping up the rupiah if exporters prefer not to convert their dollar into rupiah (over fear of rupiah depreciation).

Sentiment is influenced by a myriad of factors. One in the minds of many market participants today is the concern over global deleveraging, which is essentially the worldwide repayment of debt which has been used to finance investment positions.

In this regard, global economic developments should be closely monitored. For example, if bank losses in the US keep mounting, credit lines will be cut and debt will not be rolled over. With leverage disappearing, funds and other investors unwind their positions in emerging markets and return to their base currency.

As cross-border debt is mostly denominated in dollar, so it is no wonder that deleveraging has so far been dollar-positive.

Data from a quarterly survey conducted by the Basel-based BIS (Bank for International Settlements) gives us an idea of the magnitude of global deleveraging that's going on nowadays.

How much cross-border debt is being repaid? In the third quarter of 2008, international consolidated claims of banks surveyed by BIS declined by $1.6 trillion. This is roughly equivalent to 3 to 4 times the size of the Indonesian economy.

Few can foresee when this global deleveraging process will stop. But at least one thing is obvious: As long as US house prices keep falling and unemployment rising, potential global bank losses will widen and the deleveraging process may continue.

When US home prices will bottom is everybody's guess. But by simply projecting recent trends, they will probably not return to their 2002 *pre-bubble' levels until the second half of this year. However even that doesn't guarantee we will be out of the woods. There is still uncertainty over when and how high unemployment will peak. And to this, the sky's the limit.

Are we being all too gloomy? Well, the bright side is that the markets are indeed hard to predict. And markets are usually ahead of the economy.

When signs appear that global deleveraging will come to an end, real (non everaged) funds should eventually return to emerging markets in search of yields.

In this regard, it helps to know that Indonesia - given its low debt ratios, conservative fiscal stance and stable democracy - is among the healthiest of emerging market economies today. The turnaround will eventually come; and when it does, we should be ready.

The writer is currently an economist at Bank Danamon Indonesia

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