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ollowing Bank Indonesia’s (BI) decision to raise its reference rate by a significant amount last month to stem the slide of the rupiah, the rupiah has not budged from its position. The rupiah strengthened against the United States dollar after BI raised its seven-day reverse repo rate by 50 basis points to 5.25 percent.

However, one week after BI’s decision, its value dropped again to Rp 14,409 against the dollar, slightly worse than the level recorded before BI raised the interest rate.

BI seems to be overwhelmed by a multitude of negative factors surrounding the rupiah, and if BI ammunition becomes less effective in defending the rupiah, it will have to resort to more market intervention — a more risky action — which would result in the accelerated depletion of its external reserves.

And BI’s actions would be more costly since its rate increase could adversely affect economic growth. With BI’s rate rise, it would be difficult for banks to expand its lending growth to support the economy.

For some time, the rupiah has been under pressure from the tightening of US monetary policy. But the rupiah is also facing financial market turbulence triggered by President Donald Trump‘s move to wreak havoc on the international trading system by declaring a trade war against the US’ main trading partners.

On the domestic side, the persistent deficit in the Indonesian current accounts has not been helpful in BI’s efforts to defend the rupiah.

Market concern for Indonesian external risk has been reflected in the decline of foreign direct investment (FDI), which fell from US$8.1 billion in the third quarter of last year to $3.1 billion in the first quarter of 2018. Portfolio investment flows, which were in surplus of $20.7 billion last year, turned into a deficit of $1.2 billion in the first quarter of 2018.

Although BI has been working hard in its domain to defend the rupiah, but the value of the rupiah depends on other factors beyond BI’s control. There is evidence that a negative current-account balance could aggravate a country’s currency in the middle of market volatility.

Turkey suffered a current-account deficit equal to 5.5 percent of its gross domestic product (GDP) and its currency fell 17 percent. India’s rupee fell 7 percent because its current accounts suffered deficit of 1.9 percent to GDP.

During the same period, Argentina’s peso fell 33 percent and suffered a current- account deficit of 5.3 percent to GDP.

Argentina has to request a loan from the International Monetary Fund (IMF) of $50 billion to prevent it from plunging into financial crisis. Meanwhile, Thai’s baht strengthened by nearly 2 percent and the Malaysian ringgit was up by 0. 1 percent.

The two countries had current-account surpluses of 10.2 and 3.2 percent of their GDP, respectively.

The health of the balance sheet and its current accounts play an important role in ensuring the stability of a country’s currency. In a country with strong current accounts, the capital flight will generally be minimal when there is economic shock.

Conversely, a weak current-account balance may cause decline in market confidence and trigger foreign capital outflow when there is financial turmoil.

This is the situation that Indonesia is in now. The Jakarta Composite Index (JCI) has fallen 1. 7 percent in one week, and was down 10. 2 percent since the beginning of the year.

Unfortunately, the outlook for Indonesia’s balance of payments this year is becoming more uncertain owing to the confusion of investors all over the world over the direction and unpredictability of President Trump’s policies and the degree and pace of US Fed monetary policy tightening.

Trump’s trade war against China officially started on July 6, when the US increased tariffs on 800 Chinese export items valued at $34 billion. China said it would retaliate by slapping a tariff on 545 US export items of the same value.

The fight could get uglier as more and more tariffs are imposed on those countries’ exports. The economic impact that would spill over from this trade war into the world economy is worrying.

During the first five months of 2018, Indonesian trade has been hit by unbalanced growth between imports and exports.

Up to May, exports had grown by 9. 6 percent, while imports grew 24.7 percent. This means imports have been growing at a rate of 2. 5 times export growth.

Because of this gap, trade deficits for the first two months of the quarter (April and May) reached $3.1 billion, a significant increase from the deficit in the first two months of the previous quarter, which was $8 million.

This trade deficit would of course put further pressure on the current-account balance. It is understandable that one of BI’s deputy governors projected that the current-account deficit in the second quarter would rise to 2. 5 percent to GDP from 2. 1 percent to GDP in the first quarter.

At the same time, capital inflows — both FDI and portfolio — could not be expected to be robust as last year. So it is likely that the overall balance of payments this year would be in deficits, repeating the pattern of first quarter 2018, when the deficit reached $3. 9 billion.

The exchange reserve stood at $123 billion at the end of March, a decline of $9 billion from the end of January 2018. This means our exchange reserves have depleted at a rate of $2. 25 billion per month.

The prospect of deficit in the balance of payments and the need for BI to carry out market intervention to defend the rupiah, means that the depletion reserves will continue. And it remains to be a hard fight for BI to defend the rupiah.
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