Analysis-Indonesia’s defences start crumbling against relentless dollar

By Rae Wee and Summer Zhen

SINGAPORE (Reuters) – Indonesia’s currency is tumbling and foreign money in its bond markets is heading for the exits, stoking fears Southeast Asia’s largest economy is finally starting to crack after months of remarkable resilience against global headwinds.

Despite its history of relentless market thrashing during global economic crises, Indonesia was a surprise outperformer through August, buoyed in large part by its exports of gas, palm oil and other valuable commodities.

Its stock market is Asia’s best performer this year and the rupiah fell just 3% against a strong US dollar in the six months to the end of August, while South Korea’s won and Thai baht both fell more than 10%.

But September took a turn for the worse as the rupiah tumbled 2.5%, its biggest monthly decline this year and more in line with its Asian peers, leading analysts and investors who were ringing alarm bells over old, well-known risks: dwindling foreign exchange reserves, rising debt obligations and foreign capital flight.

“It’s kind of a catch-up or catch-up effect,” said Galvin Chia, emerging markets strategist at NatWest Markets. He blamed volatile external factors for the currency’s crash, including the dollar’s inexorable rise.

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But this time, market experts say, will be different as Indonesia’s relatively sound economy and monetary policy will help it withstand the kind of blows it has suffered in past crises.

“You still have decent carry, you still have a central bank, at least now, that’s more proactive and has a lot of credibility, and you still have tailwind from commodities,” said Ihab Salib, senior portfolio manager and head of international fixed income Group at Federated Hermes.

“I think all of this together suggests to me that Indonesia might be doing better on a relative basis.”

The rupiah’s historical vulnerability was due to its status as a risky but rewarding “carry” trade that attracted large foreign holdings of Indonesian bonds when yields in more developed markets offered relatively meager returns.

During the previous Federal Reserve tightening cycle in 2018, the rupiah fell to multi-decade lows. It plummeted 20% during the 2013 taper tantrum.


But rising commodity prices have been a restraint this year as a widening current account surplus provided a cushion against capital outflows. Foreign ownership of Indonesian bonds, which made up half of the market a decade ago, is also lower at around 14%.

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But Indonesia’s yield advantage is eroding as interest rates rise faster elsewhere. Outflows from the bond market, where yields are as high as 7%, hit $11 billion in the first three quarters of 2022, almost double the $5.7 billion for all of 2021.

“I suspect it’s more of a delayed reaction,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank, in reference to the rupiah’s recent decline.

“There are some extraordinary factors, but none of them would provide such a panacea for the remaining underlying risks.”

With no signs that the rising dollar will peak any time soon, Varathan highlights the risks that Indonesia’s external debt obligations and shrinking foreign exchange reserves could become a concern while domestic policy tightening hit growth.

“If these things start conspiring … we could have a pretty abrupt succession of capital outflows.”

Indonesia’s foreign exchange reserves fell $1.4 billion to $130.8 billion last month on debt payments and Bank Indonesia’s efforts to stabilize the rupiah.

Data for September also showed Indonesian inflation rising to a seven-year high, reflecting a rise in fuel prices.

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The stock market remains a bright spot, however, as investors are betting that prices for oil and other resources that Indonesia exports will remain high. Jakarta’s benchmark index, which was up more than 3% year-to-date as of Friday’s close, is among the few to have risen this year, along with Brazil’s Bovespa index, which is up almost 7%.

Bank Indonesia, which until recently was one of the last dovish central banks in the world, raising concerns about inflationary worries, also reassured markets last month with a surprisingly aggressive 50 basis point hike in interest rates, which it carried out as a precautionary measure to rein in inflation expectations.

“Indonesia remains a very good story in Asian portfolios,” said Rajat Agarwal, Asia equity strategist at Societe Generale SA.

“If you look at consumption, look at credit growth, it’s all domestic, unlike the other export markets in Asia. Indonesia would be one of the more resilient markets given the current backdrop.”

(Reporting by Rae Wee in Singapore and Summer Zhen in Hong Kong; Additional reporting by Patturaja Murugaboopathy in Bangalore; Editing by Vidya Ranganathan and Edmund Klamann)


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