Rupiah’s slide sparks crisis fears in Indonesia

With the rupiah plumbing new lows, fears are rising in some business quarters that Indonesia’s government may implement mandatory exchange controls if it fails in efforts underway to encourage the repatriation of export earnings for conversion into the local currency.

While such a market intervention still appears unlikely, the beleaguered currency continues to trade at a worrying 15,200-15,300 to the US dollar – a 10% depreciation in the past 10 months – and is still seemingly on a stubborn downward spiral.

“It’s got more to go,” says one senior banker, pointing to the strength of the US economy and the hike in US interest rates as the “first cause” of the rupiah’s weakness, followed by Indonesia’s current account deficit and questions over its fiscal management.

Exchange controls would undermine the free foreign exchange model that has kept the Indonesian economy on track for the past half century and also add to the much-criticized regulatory overreach that has marked the policies of the past two governments.

The first step in that direction was actually taken during the Susilo Bambang Yudhoyono administration when Bank Indonesia (BI), the country’s central bank, ruled that only US$100,000 a month could be purchased in foreign currency without an underlying transaction to support it.

Three years ago, the Joko Widodo government lowered the limit to US$25,000, but as the banker noted: “The odds may be higher now, but going further than that would have to be a move of last resort. Symbolically it would have a big effect.”

Leaving the muscular dollar aside, the burgeoning US-China trade war, rising global oil prices and falling currencies in countries as diverse as Argentina, South Africa, Turkey and India have all had an impact on the rupiah.

But Indonesia’s vulnerability also stems in large part from its bulging current account deficit. Indonesia remains one of the few countries in Asia to run a deficit, which in the second quarter climbed to a four-year high of US$8.03 billion, or 3% of gross domestic product (GDP), compared to 2.15% in the first quarter.

Central bank governor Perry Warjiyo notes that the third and fourth quarters are usually lower and says the government expects the current account deficit will finish the year at below the mandated 3% threshold. That would still be well above the 1.7% and 1.8% recorded in 2016 and 2017 respectively.

BI has increased interest rates five times since last May, the last being a 25-basis point hike in the seven-day reverse repo rate at the end of September which brought the benchmark rate to 5.75%, against 4.25% at the start of the year.

The reverse repo rate replaced the previous BI reference rate in August 2016 as a method often used by central banks to create a stronger relationship to money market interest rates.

BI interventions, along with trade and current account deficits, have taken a bite out of foreign exchange reserves, which stood at US$114.8 billion at the end of September, compared to US$117.4 billion a month earlier, equal to about seven months of imports.

The government has sought to narrow the deficit by raising taxes on 1,000 imported items, delaying infrastructure projects and widening the use of biodiesel, but the World Bank says such measures are unlikely to have any significant impact in the near term.

Most of the selected imports are consumer goods, which represent only 9% of the overall value of imports, and any meaningful conversion to biodiesel, possibly using older crude oil refineries, will also take time.

Warjiyo insists the economy’s fundamentals are sound and scoffs at comparisons to the 1997-98 Asian financial crisis, when the rupiah lost 80% of its value, plunging to 16,000 to the dollar.

All the same, the rupiah’s weakness has drawn attention to the health of the banking system, with Moody’s Investors Service changing its outlook from positive to stable in an apparent reaction to a deterioration in asset quality.

Overall, non-performing loans (NPLs) amounted to an outwardly acceptable 2.94% of total lending for the first half of 2018. But so-called special mention loans, or those that require closer attention from BI, rose to nearly 5% in the same period.

While there are few overt worries about the four state and one private bank which make up the top tier, or Buku 1, the state institutions have a high percentage of restructured loans, known as zombie loans, which are not part of NPL calculations.

Banking sources explain that bad debts accrued by state banks can be construed as losses to the state, which, however controversial, are grounds for an investigation by the Corruption Eradication Commission (KPK).

Analysts say some of the 100 smaller Buku 1 and 2 banks, which engage in more risk taking because of their lower deposit bases, are having problems with subprime borrowers – one reason why BI is encouraging foreign banks to step up acquisitions.

While President Widodo’s opponents will seek to make political capital out of the rupiah’s woes in the lead up to next April’s presidential and legislative elections, the 187 million eligible voters are more likely to be swayed by any rise in the price of basic commodities.

On that front, inflation has continued to stay remarkably stable, with the cost of living index slowing from a high of 3.34% year-on-year in April to only 2.88% at the end of September, the lowest level in two years despite the rupiah’s troubles.

But that’s due in large part to billions of dollars spent in state subsidies that have cushioned the population from inflationary increases in the price of food, fuel, electricity and agricultural inputs such as seeds and fertilizer.

On October 10, the government reversed Energy and Mineral Resources Minister Ignasius Jonan’s shock announcement, made an hour earlier, to increase price-capped diesel and premium gasoline by an average of 7% percent.

The policy flip-flop was made even more embarrassing by the fact that it was played out in Bali, where Jonan and other ministers are attending the World Bank-International Monetary Fund’s annual meeting. Says one senior official: “We all asked, ‘What is he doing?’”

State Enterprise Minister Rini Soemarno countermanded the price increase, saying it had yet to be discussed. But it is understood she was acting on the instructions of Widodo, who arrived on the tourist island later that evening.

The episode baffled the business community in the way it exposed apparent flaws in government policy-making and ministerial coordination and, more importantly, raised questions over whether Jonan would have acted without the president’s go-ahead on such a crucial issue.

Subsidies this year account for 14% of the government’s budget, but they do not reflect the extra costs absorbed by state-owned enterprises, especially the Pertamina oil company which is required to maintain a same-price fuel policy across the country.

With earnings reportedly down 45% for the first half of this year, Pertamina’s failure to maintain production at the Mahakam gas-field is a clear sign of its inability to spend on new wells, while the government itself loses revenue by forcing gas and coal producers to sell part of their output at below-market prices.

Although foreign direct investment dropped by 13% in the second quarter, capital equipment imports through August were recorded at US$19 billion, up 25% year-on-year in a continuing reversal of what up to 2017 had been a three-year decline.

Exports were also up in the second quarter, but the 10% increase wasn’t enough to forestall a US$4 billion trade imbalance, with the manufacturing sector only growing by a modest 4.3%, well below the overall 5.2% growth rate for the first half of the year.

With Indonesia losing out to Vietnam and other neighboring countries as China moves some of its manufacturing offshore, an impatient Widodo has moved a newly-revamped one-stop shop for foreign investors from the Investment Coordinating Board (BKPM) to the Economic Coordinating Ministry.

The move seemed to reflect a loss of confidence in BKPM chairman and former trade minister Thomas Lembong in managing the transition to an online business licensing system which aims to attract more foreign investment.

But there may be good investment news around the corner. Both Widodo and Finance Minister Sri Mulyani Indrawati say Indonesia has the inside running for a new US$1.3 billion Amazon Web Services cloud computing unit. If ever a confidence booster was needed, now is the time.