The rupiah, one of the top gainers against the US dollar in 2011, could end up as one of the worst performing currencies in the region this year — which would be strange, as Indonesia’s economy continues to grow robustly.
Even though the nation’s annual economic growth rate may have declined slightly from last year’s respectable 6.5 percent, it will still most likely end up around 6.3 percent for 2012, which would be the second-highest rate of growth in the world after China.
Last week, the rupiah fell to a near-three-year low of Rp 9,733, due to the combined impact of a year-end surge in demand for US dollars and a rise in portfolio capital outflows from the stock exchange.
True, as Bank Indonesia spokesperson Difi Johansyah noted, there has always been a higher rise in demand for greenbacks toward the end of the year, as foreign companies fulfill obligations to transfer profits to their principals overseas.
However, the rate of rupiah depreciation this month has been much faster than in December 2011, indicating that there must be another big factor at work, besides what BI Governor Darmin Nasution described as a cyclical trend that has pressed down the rupiah.
We share the prevailing view of analysts that concerns about the large risk posed by a rising current account deficit (CAD) have been an important factor behind bearish sentiments.
The nation’s CAD did decrease to US$5.3 billion, or 2.4 percent of gross domestic product, in the third quarter, from $7.1 billion, or 3.2 percent of GDP, in the second quarter.
However, the Central Statistics Agency announced earlier this month that the nation had booked a record trade deficit of $1.54 billion in October, further heightening market worries about the mounting downside risks of worsening CAD in coming months.
Further, the nation’s foreign trade balance for the first 10 months of 2012 resulted in a deficit of $500 million, a far cry from the cumulative trade surplus of $26 billion booked in the same period last year, when the country’s exports and the prices of its major export commodities had not yet suffered the brunt of the crisis in the European economy and the weakening recovery in the US.
The problem is that imports, which rose by over 10 percent in October, will most likely continue to increase, due to higher imports of capital goods driven by robust expansion in investment, notably in basic infrastructure, and of basic materials and intermediate goods to meet domestic consumption, the main locomotive of growth.
Having said all that, we don’t mean to exaggerate fear of a faster rate of rupiah depreciation soon or next year. BI’s holding of international reserves still totaled over $111 billion as of this month — more than enough to finance of six months of imports.
However, the central bank will face bigger challenges in managing the external balance to protect the rupiah from too-steep depreciation, because a much weaker currency will raise the costs of imports (imported inflation), thereby increasing inflationary pressure.
Such conditions could in turn prompt the central bank to raise its benchmark interest rate, which it has vowed to maintain at 5.75 percent until the end of the year, to keep inflation under its target of 4.5 percent, plus or minus 100 basis points. The potential trouble is that a further rise in lending rates, already the highest in the region, will hurt the economy.