Since the beginning of 2018, the rupiah has weakened against the United States dollar to as low as Rp 14,200. Even though the currency recovered slightly after Bank Indonesia’s preemptive move to raise its policy rate by 50 basis points to 4.75 percent last month, the rupiah remains under pressure.
There are at least two fundamental factors influencing the movement of the rupiah. The first is the difference in inflation rates. The currency of a country with a relatively high inflation rate tends to weaken. This is related to the theory of Purchasing Power Parity (PPP), used to analyze the effect of inflation between two countries on foreign exchange rates using two variables; the spot exchange rate and the difference in inflation rate between two countries.
The theory concludes that the spot exchange rate of a currency changes in reaction to inflation....
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