Saturday, August 22, 2015

Global Markets on Fire: What Happens to the Rupiah & Indonesian Stocks?

The Indonesian rupiah continues to flirt with a 17-year low as the currency is getting closer and closer to the IDR 14,000 per US dollar level. Meanwhile, Indonesian stocks took another blow as the country’s benchmark stock index (Jakarta Composite Index) fell 2.39 percent on Friday (21/08). Such turmoil is not only confined to Indonesia but was felt across Asia and the West. Markets were plagued by selloffs in energy shares (due to falling oil prices) and uncertainty about the timing of higher US interest rates.
The Shanghai Composite Index fell 4.27 percent on Friday (21/08). Chinese stocks have been plagued by remarkable volatility over the past few months after the bursting of a stock market bubble this summer and the recent devaluation of the yuan. Investors are concerned that Chinese policymakers are not able to boost the country’s sluggish economic growth.

Last week, the central bank of China (the People's Bank of China) allowed its yuan (also known as renminbi) to depreciate nearly 3.5 percent against the US dollar in an apparent attempt to boost the country’s export performance and economic growth. However, this could also be the trigger of a currency war as several other Asian countries need to keep their export products competitive. For example, the central bank of Vietnam immediately devalued its dong (for the third time this year) by one percent and raised the scope for currency fluctuation to three percent (on either side). This move was partly responsible for falling Vietnamese stocks. The benchmark Vietnam VN index was this week’s worst performing regional stock index, weakening 5.6 percent.

Meanwhile, the Jakarta Composite Index (IHSG) fell 2.39 percent to 4,335.95 points on the last trading day of the week. In line with other Asian indices, the IHSG has fallen into bearish territory (falling far from its April 2015 peak of 5,523.29 points) and this negative performance may continue in the next couple of months as the Federal Reserve could delay its interest rate hike, prolonging global uncertainty.

An important internal factor that contributes to the weak performance of Indonesian stocks and the rupiah is sluggish government spending. Due to red tape the Joko Widodo-led government is yet to start its ambitious infrastructure development program. With Indonesia’s GDP growth having slowed to a six-year low of 4.67 percent (y/y) in Q2-2015, investors are doubting the ability of the government to accelerate the nation’s economic growth. Foreign investors have shifted from Indonesian stocks to coupon-guaranteed government bonds. Currently foreigners hold 38.3 percent of government bonds (IDR 532.7 trillion), up 25 percent from the same period last year. Recent yuan depreciation puts more pressure on Indonesia’s economic growth as a weak yuan makes imports more expensive for Chinese importers and therefore commodity prices are expected to continue to slide.

Next week, the IHSG is expected to remain under high pressure as the US Dow Jones Industrial Average, which opens after Asian markets are closed, plunged a staggering 3.12 percent on Friday. Similarly, European indices faced severe selling on Friday on a sharp drop in oil prices on increased fears over the health of the world’s largest consumer, China.Flash content not available on Ipad

The Indonesian rupiah, which is not pegged to the US dollar, has been depreciating since the US Federal Reserve started to speculate about tightening its monetary approach (this speculation started in late May 2013). The winding down of the US quantitative easing program means the end of cheap US dollars flowing to emerging markets. The next step is higher US interest rates. This would imply more capital outflows from emerging markets as US yields become more attractive. Although the Federal Reserve’s latest FOMC minutes signal that a US interest rate hike is coming closer (as US macroeconomic data is supportive), recent high volatility - triggered by China’s monetary policy - has created doubt over the Fed’s ability to raise interest rates in September, implying that we are experiencing a prolonged period of uncertainty (something which is highly disliked by investors).

Unlike central banks in China and Vietnam, Indonesia’s central bank (Bank Indonesia) claims it is fighting the depreciation of the rupiah in order to maintain macroeconomic stability. It has used part of its foreign exchange reserves to support the rupiah and tried to thwart speculators by limiting the maximum amount of non-collateral foreign exchange purchases at USD $25,000 per month (down from USD $100,000). Those who purchase foreign currencies worth over USD $25,000 per month now need to provide various details to authorities (such as a report of underlying collateral, their export or import activities, and their taxpayer numbers).

In response to rupiah depreciation, Indonesian Finance Minister Bambang Brodjonegoro said the current value of the rupiah is not in line with the country’s economic fundamentals (hence being undervalued). According to Brodjonegoro global markets are currently being plagued by irrational behaviour of investors amid heightened global uncertainty. This leads to falling stock markets across the globe and weakening emerging market currencies as investors are seeking safe haven assets (such as the US dollar, gold and government bonds).

Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) depreciated 0.41 percent to IDR 13,895 per US dollar on Friday (21/08). The currency has weakened nearly 12 percent against the US dollar so far this year.


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