Global Business Guide Indonesia

Indonesia
Sign up for the GBG Indonesia Quarterly Business Intelligence Report for the latest news on your sector.
Sign Up
Business Updates | Indonesia’s Fragility & The Fed

The April 2016 meeting of the US Federal Reserve (Fed) took international investors by surprise as the minutes of the meeting indicated that an interest rate rise may be on the cards as early as this month (June). For Indonesia, such a rate rise will serve as a test of the reforms that have been underway for the past year which have focused on increasing national competitiveness, enforcing greater fiscal discipline, simplifying bureaucracy to encourage investment as well as targeting flagging consumer spending. The weakening of the rupiah, which began to tumble from 2013 and declined sharply throughout 2015, has placed Indonesia among the ‘Fragile Five’ economies that are susceptible to US dollar sell offs.

Since the start of 2016, the rupiah has rallied and remained relatively stable, hovering at around 13,200 IDR to $1 USD from its weakest point in September 2015 when it plunged to 14,600 IDR; a valuation not seen since the Asian Financial Crisis (See The Present Plight of the Indonesian Rupiah). President Joko Widodo has credited his government’s policies focused on reducing Indonesia’s external liabilities for the new-found stability, however other factors related to global monetary policy are a more likely explanation which will bring the success of the recent reforms and the question of Indonesia’s fragility into the spotlight should the Fed proceed with a hike in interest rates.

More macro than micro

On the macro side, the ongoing stimulus programme by the European Central Bank as well as the Japan Central Bank’s shift to negative interest rates have once again endeared emerging markets to investors. This has bolstered the rupiah, alongside other Asian and emerging market currencies thus playing a key role in its stability over the course of 2016. However, the extent to which the currency is still vulnerable to external shocks was laid bare after the Fed’s alarming announcement in April which saw a return to volatility for the currency as it dipped to its lowest level since February 2016, with a similar trend reflected on the stock market. This slump was extended following Standard & Poor’s (S&P - a rating agency) decision to not upgrade Indonesia’s rating to investment status at the end of May. Yet, the decline was stemmed by Fitch Ratings' (a rating agency) decision to maintain Indonesia’s investment grade.

Investors have been treating Indonesian bonds at investment grade since 2012, however the move by S&P was a timely reminder of the material limitations of reform announcements versus reform implementation. The 12 economic policy packages issued by the Jokowi government (See Indonesia’s Economic Stimulus Packages) as well as further proposed amendments to the Negative Investment List (See Indonesia Foreign Investment - The 2016 Negative List) have certainly served to pique interest in Indonesia as an investment destination. In 1Q16, Indonesia’s FDI figures rose 17.1% year on year with a total value of 96.1 trillion IDR and in line with the government’s target for the year. However, despite the increase in FDI in rupiah terms, the expected reforms that investors are looking for that will see this streak continue are still lacking. As late as May 2016, President Jokowi finally signed off on implementing regulations for the packages which will enable them to actually take full effect not to mention the lack of uniformity in application across regions outside of West Java.

Not stuck on repeat

Indonesia is in a significantly stronger position versus where it was in 2015, having brought inflation under the Bank Indonesia target range and reduced external vulnerabilities by keeping the current account deficit in check; even though projected GDP growth remains at 4.8% and below the government’s 5.3% target for 2016. Appetite for Indonesian bonds remains strong among international investors and this is likely to continue even after a Fed rate hike as the Indonesian government provides one of the highest returns in Asia with the 10-year yield at 7.85%. This should make investors less flighty should a rate rise come into place, but may not be sufficient to stem a sell off if Bank Indonesia recommences monetary easing policies.

The Fed is expected to announce whether it will go ahead with the interest rate rise after their meeting on the 14th-15th June 2016. Bank Indonesia appears confident on the rate rise, stating that recent volatility is in line with normal patterns of investor behaviour prior to Federal Open Market Committee meetings. This confidence seems well founded; the likelihood is that a US interest rate rise will bring about short term volatility for the rupiah, but not on the scale that was experienced over 2015 and not for an extended period of time. Looking ahead, retaining the rupiah’s stability should remain the priority for Bank Indonesia as it is this stability that will maintain investor confidence in Indonesian bonds and encourage private sector investment which has stagnated since last year off the back of persistent uncertainty. 

Global Business Guide Indonesia - 3rd june 2016

icone share