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ontinued exchange-rate flexibility and limited market intervention on the rupiah could create a safety buffer for Indonesia ahead of the global financial shocks likely to occur this year, the International Monetary Fund (IMF) has advised.

In its recently released staff report on the country, the IMF warned that external risks in the global economy could exacerbate strains in the banking and corporate sector, as unexpected surges in financial market volatility could increase balance of payments and bank-funding pressures.

'€œIndonesia'€™s external position is found to be moderately weaker than implied by medium-term fundamentals and desirable policies,'€ the IMF wrote in its report.

'€œStaff noted the need for continued exchange rate and bond-yield flexibility as the primary response against external shocks, with BI [Bank Indonesia] limiting intervention in the foreign exchange market to smoothing volatility,'€ the fund said.

While the rupiah has weakened significantly since 2013, the currency is overvalued by around 5 percent in real-effective exchange rate (REER) terms from its ideal value to narrow the country'€™s current-account deficit, according to the IMF.

A currency that is overvalued in its REER '€” an inflation-adjusted value of the currency that reflects its true competitiveness '€” means it is trading stronger than its fundamentals, consequently harming the country'€™s exports.

An overvalued rupiah also discourages foreign fund inflows as local currency assets such as stocks and equities become relatively expensive for foreign investors when compared to those in other countries.

'€œOver the medium term, the lagged effects of the weaker rupiah should help lower the current-account deficit,'€ the IMF said.

The rupiah has lost ground by 6 percent against the US dollar this year, among the worst performers in Asia, after falling by more than 2 percent last year, but the currency appreciated in REER terms as it has strengthened against non dollar-currencies.

This is because some of the world'€™s central banks from Australia, Europe to Japan are deliberately weakening their respective currencies to boost trade competitiveness through interest-rate cuts and other forms of monetary stimulus.

As of January this year, the rupiah was 3.9 percent stronger year-on-year on a trade-weighted basis, the World Bank said in its High Expectations report released this month, quoting data from the Bank of International Settlement (BIS).

'€œWe frequently compare the rupiah to its value in the past and that is not meaningful in terms of economic perspective,'€ commented Ndiame Diop, World Bank lead economist for Indonesia. '€œWhat is important [for the rupiah] is its relative value, especially in terms of countries with which Indonesia is trading.'€

In response to the weakening rupiah, BI has been adopting a prudent and well-calibrated market intervention strategy, with the central bank opting to pile up its foreign exchange (forex) reserves as a safety buffer against capital shocks.

Central bank executives have frequently stated that their forex market operations would focus on smoothening volatility rather than holding the currency at a certain level.

BI'€™s foreign exchange reserves, used to supply dollars in the market, had risen to US$115.5 billion by the end of February from $98 billion in June 2013.