In the third quarter of 2014, emerging market currencies have been feeling the heat as investors sold off their holdings in emerging market currencies and bought into US Dollars in anticipation of US interest rate normalisation. Indonesia Rupiah was not spared as the domestic economy was hit hard by failing commodity prices such as oil and palm oil.
However, the newly elected President Joko Widodo has taken bold measures to stem the Rupiah’s depreciation which not only surprised market participants but managed to gained investors confidence at the same time. On November 17th, the premier announced a fuel price hike of IDR 2,000 per litre. The decision to slash the traditional subsidy that has been weighing on Indonesia’s finances for decades could push inflation above Bank of Indonesia’s new inflation target of 3 to 5%. The impact of the fuel hike is most likely to be reflected in Indonesia’s December CPI.
This move will be able to free up state funds and allow Joko Widodo’s administration to spend more on the much needed infrastructure, education and health development policies, a pledge that he promised to deliver prior to taking office. Investors applauded the move as it is a tough and unpopular decision but vital to turn around Indonesia’s struggling economy. This move also shows that reform momentum is gaining traction.
The second move came a day after the fuel hike where Bank of Indonesia hiked its policy rate by 25 basis points taking it up to 7.75%. The move was coupled with an easing in the loan to deposit ratio (LDR). The rate hike is to counter the inflation expectations from the increase in fuel prices but at the same time they do not wish to hamper growth. By easing the LDR, banks will be willing to lend out more and bring down the cost of borrowing which will then spur investment and business. These two measures taken by Widodo’s administration sent a strong signal to investors that they are committed to turn around Indonesia’s economy.
Joko Widodo’s decision to hike fuel prices and policy rate is supportive for the Indonesia Rupiah. In the middle of November, data from Indonesia’s finance ministry showed that investors pumped in 12.5 trillion rupiah into Rupiah notes, signalling confidence from investors. Market participants are expecting an improved current account position for 2015 as we continue to expect Joko Widodo to cut down unnecessary government spending, such as the recent cut on government travel and meetings expenditure.
We continue to hold a positive view on the Rupiah relative to other Asian currencies however volatility is expected flow through the spot and Non Deliverable Forward markets as the impact from US interest rates normalisation remains high. With the recent volatility experienced in the domestic currency, it presents both risks and opportunities to investors looking to hedge their currency exposures.