The decline of the rupiah is not a short-term phenomena such as a temporary shortage caused by seasonal demand from importers. The decline has been going on since the start of the year, and is the result of several factors: the deteriorating trade balance, capital outflows and uncertainty in government policies.
The prolonged global economic slowdown has finally affected Indonesian exports, even though this came later than to other countries. Even though exports still rose 4 percent year on year between January-April, it was below the 7 percent increase in the first quarter last year. Over the same period, the trade surplus was US$2.1 billion, a fall of almost 75 percent from the same period last year.
Driven by high growth, imports are running at a faster pace than exports, eroding the Indonesian trade balance. The weakening of the rupiah will benefit exports in the medium term.
But since some export industries have high import contents, the overall benefit will be offset by the higher cost of raw materials.
Imports of raw materials, which constitute the bulk of imports, are not only used for production for the domestic market but are also used by export-oriented industries such as textiles, electronics, motor vehicle parts, machinery and many other manufactured products.
These high-import-content export industries comprise around 25 percent of manufacturing value-added and employ around 20 percent of the labor force.
The higher costs of raw-material imports have put these industries into a more difficult competitive situation, which could slow down their export growth, aggravating the trade balance.
The severity of the eurozone debt crisis has triggered investors to move their financial assets from emerging markets considered risky into safer assets mostly US Treasury Notes.
The large sell-off of equities in the Jakarta Stock Exchange and Indonesian government debt notes has resulted in capital outflows plunging the rupiah to the range of Rp 9,400–9,500 for one US dollar.
The volatility of share prices and the rupiah will continue as investors await the results of the June 17 election in Greece, where the fate of the eurozone will be decided. If a Greek exit from the eurozone is unavoidable, the repercussions will shake the financial markets all over the world.
The default by the Greek government on their sovereign debt if they exited the eurozone would weaken banks across Europe and could threaten several bankruptcies and the need for large bank bailouts. Banks in some peripheral countries such as Spain and Italy have been on the brink, and even one of the biggest banks in Spain had to be bailed out by the government recently.
Unfortunately, in the midst of rising volatility in the world capital market, the Indonesian government has implemented several policies that could adversely affect the business environment in terms of certainty.
These can be seen in the cases of fuel subsidies, mining, trade, and bank-ownership rules. The credibility of government policymaking is being eroded by the lack of decisiveness and clarity in those policies.
Investors also realize that the House of Representatives has still not approved the financial safety net bill that has been submitted by the government.
A government regulation in-lieu-of-law (Perpu No. 4/2008) allows the government and Bank Indonesia (BI), the central bank, to jointly inject emergency liquidity into financial institutions — not just banks — in the event of potential systemic collapse, without first obtaining approval from the House. But a request to convert this Perpu into law was rejected by the House on the grounds that it could be misused by BI.
That means if a banking crisis resulted from the contagion in Europe, the Indonesian government would not have adequate legal basis to counter it.
Because of all these issues, investor confidence in the government is slipping, and this is not good when investors are moving their capital out of the country.
The declining investor confidence in government policies might be the reason why the effect of the debt crisis in Europe on Indonesia is more severe than its effect on other countries in the region.
The rupiah slide against the US dollar has been steeper compared with other currencies such as the Malaysian ringgit, Singapore dollar, Korean won and Indian rupee. The share price index in Kuala Lumpur between the start of the year and the end of May was up by 2.8 percent, in Bangkok it was up by 8.8 percent, and in Singapore by 3.8 percent. In Jakarta the index was up only by 0.3 percent.
In May alone, global investors reduced their ownership of Indonesian government debt by Rp 6.9 trillion ($728 million). They have also sold $157 million more of Indonesian equities than they bought. BI reserves dropped by $5 billion in May so that they now stand at $111 billion.
To reduce rupiah volatility BI has intervened in the market, but the problem with market intervention is that, so long as BI has no idea what the appropriate level of the rupiah exchange rate is, it does not know when to stop risking its reserves. If BI feels that its reserves have fallen too far, and there is an urgent need to sustain the reserves, BI will abandon the market and leave the rupiah exchange rate to be entirely decided by the market, as has been done in the past.
So it is understandable if BI feels the need to supplement its rupiah stability measures by opening dollar term-deposits to attract the proceeds of Indonesian exporters currently deposited abroad. But it is believed that even this measure will only attract $2 billion.
It is likely then that BI will come out with additional measures. Previously to encourage portfolio funds to stay longer, BI introduced debt certificates (SBI) of longer duration of six and nine months. However, with the extreme fear of investors in the face of the deepening debt crisis in Europe, it is clear that issuing nine-month SBIs is not effective in deterring capital from leaving the country.
If the rupiah value keeps falling, it is not impossible that BI could have to resort to quasi-capital control as it did in 2008. BI could require any entity wanting to purchase foreign currency exceeding $100,000 a month in either the spot or forward market to provide a statement justifying the need for the transaction. Any measure that smacked of capital control would be shunned by investors, resulting in more capital outflows.
Rather than devising piecemeal policies, it would be more productive if both BI and the government worked more closely together to address declining investor confidence in the overall economic
policymaking with the full support from the politicians in the House.
The writer is an economist.