The rupiah closed at Rp 13,568 against the United States dollar at the end of 2017, depreciating 0.7 percent year-to-date as investment slowed in emerging markets in response to strengthening US economic data and the Federal Reserve’s (Fed) policy rate hike.

Meanwhile, Indonesia’s economic data remains positive and the rupiah has been less volatile as it has been maintained at a competitive level to the US dollar and other currencies. This positive economic data was demonstrated by the US$12 billion surplus in the accumulative trade balance as of November 2017, higher than the $8.5 billion seen in the same period a year earlier.

As a result, the current account deficit narrowed to 1.7 percent of gross domestic product in 2017. We expect the figure will stay low in 2018, supported by improving goods and services trade.

The rupiah’s depreciation last year was in line with the US dollar’s broad appreciation against most major global currencies following the normalization of the US’ monetary policy stance. Impending tax reform in the US and further Fed rate hikes toward the end of 2018 have also triggered the US dollar’s appreciation.

The rupiah’s movement has become more sensitive to short-term issues, especially external factors such as major central bank policies such as the Fed, European Central Bank and Bank of England, changes in international financial markets as well as economic developments in other major countries.

Overall, the rupiah remained calm last year and supported investor confidence in financial markets. The average daily volatility of the rupiah in 2017 was 0.13 percent, much lower than the 0.32 percent recorded a year earlier.

However, any speculation over the Fed’s recent moves, coupled with the market’s response to US President Donald Trump’s tax policies, may result in a stronger US dollar and US-based assets.

In its last December meeting, the Fed raised its benchmark rate to 1.5 percent and indicated that it would raise it further as soon as it was considered suitable, or in line with US economic recovery or other positive developments.

The latest Federal Open Market Committee meeting minutes revealed that it might be appropriate to raise rates again in 2018 if inflation continued in line with expectations of above 2 percent, as well as better employment data. The Fed’s forecast of three additional rate increases in 2018 and 2019 was unchanged from its projections in September 2017.

US gross domestic product (GDP) meanwhile, was projected to grow 2.5 percent in 2018, higher than the Fed’s previous forecast in September last year of 2.1 percent. The Fed also stated that US unemployment would fall to 3.9 percent this year and remain at the same level until 2019, well below what is considered as full employment. It had previously forecasted a jobless rate of 4.1 percent for those two years.

Recent inflationary pressures, however, have encouraged the Fed to revise upwards its median projection for inflation to 1.7 percent by the end of last year, up from the 1.6 percent forecast earlier. The median forecasts for 2018 and 2019, meanwhile, were unchanged at 1.9 percent and 2 percent, respectively.

Having said that, we predict demand for the US dollar will remain susceptible to expectations that the Fed will stick to its plan of gradual monetary tightening and the implementation of Trump’s policies, especially tax reform.

In the short and medium term, risks coming from a stronger US dollar will contribute to the rupiah’s higher volatility. Such an impact from external factors can be minimized by direct intervention in the market, including deepening financial markets through, among others, short term investment instruments, which are more attractive to investors and encourage capital inflow.

Consistency in maintaining the rupiah’s stability is an essential part of sustaining domestic economic growth. Policymakers must remain vigilant in the face of the risks arising from global economic and financial conditions that could change at any time. Indonesian money market activity can also be maintained by strengthening banking intermediary functions, which will expand when the national economy improves. Indonesia’s domestic economy is expected to grow faster this year compared to 2017.

The economy is expected to grow by 5.3 percent in 2018, supported by strong domestic consumption, improvements in the quality of government spending, increasing private investment and fiscal management. Other positive catalysts from the domestic side are foreign capital inflows, along with stable, attractive local interest rates, which are expected to boost investor confidence and create space for the rupiah’s stabilization.

The recent Fitch Ratings’ upgrade to BBB was a great achievement. The highest rating since 1995 can hopefully attract more investment to our country. On the other side, we expect that Bank Indonesia’s (BI) policy rate — the seven-day reverse repo rate — will remain flat at 4.25 percent until the end of 2018 because of stable inflation and gradual improvements in economic growth.

Several external risks will test the currency market in 2018, particularly the escalating volatility of global financial markets, which is in line with the possibility of the Fed’s normalization policies. We are still optimistic that regulators will maintain macroeconomic stability and promote economic growth. The country’s foreign exchange reserves stood at $125.9 billion, or 8.1 months of debt payments and imports as of November 2017, which is more than sufficient to stabilize the rupiah against the greenback. The reserves strengthened resilience on the external side and maintained the sustainability of the economy.

BI continues in its effort to maintain stability by providing room for growth and controlling the strong position of Indonesia’s reserve assets. The central bank will also continue to stabilize the rupiah in line with the currency’s fundamental value, while also maintaining market mechanisms. We expect the rupiah will fluctuate between Rp 13,380 and Rp 13,625 against US dollar in 2018.
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The writer is a senior quantitative analyst at Bank Mandiri.