Indonesia is facing its
most serious currency crisis in 17 years.
With the recent plunge of the Indonesian rupiah from one of Asia’s
best-performing currencies to one of its worst, many fear that the specter of
the 1997 Asian financial crisis has returned to haunt the archipelago’s sandy
beaches.
At
present, the Indonesian rupiah (IDR) trades at roughly 13,000 to one U.S.
dollar (USD), its weakest level since 1998. The ongoing currency depreciation
may pose the greatest threat to Indonesia’s economy in more than a decade
unless the government acts decisively to rectify the situation.
For this
reason, President Joko Widodo, commonly called Jokowi, must prioritize the
stabilization of Indonesia’s weakening rupiah if Southeast Asia’s largest
economy is to sustain its rapid growth. A failure by the president to
demonstrate strong economic leadership would undermine his credibility and have
a chilling effect for commercial activity in the region.
While
rarely the focal point of the global economy, the Indonesian rupiah, the legal
tender of Indonesia and its 250 million citizens, is historically one of Asia’s
highest-yielding currencies. However, its openness to foreign capital flows has
backfired in the past, most notoriously during the 1997 Asian financial crisis
– a watershed event resulting in the removal of the president, the independence
of East Timor, and riots in the street of Jakarta.
Today,
the ailing Indonesian rupiah is unlikely to find much assistance from the
global economy, as the US recovery reduces the investment appeal of emerging
markets, and ongoing weaknesses in Japan, China, and Europe damage the market
for exports. Consequently, the economic community must look to Widodo and Bank
Indonesia (BI), the country’s central bank, to stabilize the situation in
response to both foreign and domestic factors.
Internationally,
the dollar continues to strengthen as the United States economy recovers and
the U.S. Federal Reserve indicates it may shortly raise interest rates, pulling
capital away from emerging markets and weakening regional currencies.
However,
while the rise of the dollar has had implications for the entire region, the
rupiah’s fall has been the steepest in Southeast Asia because of domestic considerations.
The Jokowi administration’s decision to sharply reduce the Indonesian fuel
subsidy at the end of 2014 and general dollar/rupiah illiquidity within the
domestic foreign exchange market both exacerbated market volatility.
First,
the removal of the fuel-price subsidy, while freeing up over one hundred
trillion rupiah in government spending, induced confusion among market
participants. The resulting fuel price-hike triggered an increase in inflation
and a reduction in Indonesian rupiah bond prices – forcing the market to cut
losses on long-term bonds, or worse, choose to engage in capital flight. As
foreign investors hold roughly 38 percent of current rupiah-denominated bonds,
Jakarta must do everything it can to keep market sentiment under control.
The
current lack of liquidity within the Indonesian financial market complicates
the issue. The impact would not be as steep were Indonesian exporters to place
their revenue within the country’s banking system, but between the lure of the
adjacent Singaporean financial community and the small domestic spot market for
small-sum dollar/rupiah conversions, little incentivizes them to stay.
Jokowi
would be well served to take the weakening rupiah as a signal to pursue
economic reform while protecting the country’s competitive edge in
international markets. The subsidy reduction, combined with government revenues
from oil and gas exports, provides Jokowi with political capital, and as such
he should press his advantage by pursuing several policies to shore up the
rupiah and demonstrate economic leadership in tandem with Bank Indonesia.
Jokowi’s
immediate goal must be to take action to narrow the current-account deficit,
which has worried foreign investors for years. One straightforward means of
doing this would be to enforce a 2011 law requiring all parties’ transactions
within Indonesia to be conducted using IDR. Many companies, especially in
export-oriented industries, have been reluctant to follow the regulation as
dollar-denominated revenues effectively hedge against rupiah depreciation. The
rupiah transaction rules, long neglected, should be implemented as soon as
possible as a means of increasing the foreign currency reserve and
demonstrating the administration’s tight monetary stance.
Moreover,
Jokowi must coordinate with Bank Indonesia to convince market makers of the
rupiah’s integrity through judicious implementation of economic and monetary
policies. In the short term, this involves signaling to observers that BI has
the ability to fund Indonesia’s current account deficit and is capable of
intervention if the rupiah weakens too much. The ultimate objective must be to
improve the country’s trade balance and contain the impact of the
current-account deficit, currently at roughly three percent of gross domestic
product (GDP), on the developing economy.
This
effort must be carefully harmonized between both players. Without
communication, the danger remains that Bank Indonesia may overextend attempting
to defend the IDR from foreign exchange and deplete its currency reserves. With
confidence and trust the keys to stability, BI must avoid doing anything that
might signal to market participants it is not in control. Allowing rampant
debasement of the rupiah due to negative market opinion will produce an economic
crisis spurred onwards by spiraling inflation and reduced purchasing power,
with the ultimate outcome of increased absolute poverty.
For this
reason, trade competitiveness must be balanced with financial stability. The
administration and the central bank must work together to ensure that the
burden of economic structural deficiencies do not weigh too heavily on either
the shoulders of the Indonesian people or foreign investors in Indonesian
equities.
Jokowi’s
efforts to curb the central government’s budget have been commendable,
especially on hot-button issues that once seemed untouchable – like fuel price
policy reform. Now, as Indonesia faces its worst currency crisis in 17 years,
the president must exercise strong monetary policy acumen, working in tandem
with Bank Indonesia to stop the fall of the rupiah. With a combination of sound
macroeconomic management, a steady policy climate, and concerted government
efforts to bolster market institutions and infrastructure, the Republic of
Indonesia will weather the storm currency fluctuations have brought upon its
shores.
Matthew
Prusak is an Ethics Fellow for the Future at the Carnegie Council for Ethics in
International Affai
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