Stability In Sight For Ailing Rupiah

Short-Term Outlook

Given that the Indonesian rupiah is currently trading slightly below our end-2013 forecast of IDR11,700/US$, we are neutral on the unit over the short-term. That said, the scale of the currency's recent sell-off suggests that bearish sentiment towards the rupiah is likely peaking, and with fundamentals gradually improving, this could set the stage for a more constructive environment in 2014.

Core View

Recovery Not Yet Secured
Indonesia - Trade Balance, US$mn
Indonesia Currency Forecast
Spot S-T 2014 2015
IDR/US$, ave 11955.00 - 11600.00 11400.00
IDR/EUR, ave 16191.00 - 15428.00 14478.00
BI Rate, % eop 7.50 - 7.00 7.00
Source: BMI, November 28, 2013

Short-Term Outlook

Given that the Indonesian rupiah is currently trading slightly below our end-2013 forecast of IDR11,700/US$, we are neutral on the unit over the short-term. That said, the scale of the currency's recent sell-off suggests that bearish sentiment towards the rupiah is likely peaking, and with fundamentals gradually improving, this could set the stage for a more constructive environment in 2014.

Core View

The Indonesian rupiah has once again experienced a relatively forceful sell-off, having shed 10.8% since reaching a nearly two-month high of IDR10,750/US$ in October. Indeed, the currency's rally following the US Federal Reserve's surprise decision in September to maintain the pace of its asset purchases ended up being short-lived, with the market's focus once again turning towards Indonesia's challenging external position against the backdrop of a slowdown in economic activity.

Trade Surplus A One-Off

As we have written previously ( see 'Growth Outlook Tempered As Economy Cools', November 8), Indonesia's surprise trade surplus of US$71.6mn in August was a one-off event, with the trade account duly submerging back into a deficit of US$657.2mn in September. That said, while the veritable collapse in August imports was not confirmed by the following month's data, we believe that domestic demand for foreign goods is nevertheless likely to continue to wane. In this sense, the decline was indicative of a trend that we expect to continue, with import growth stalling as a result of higher domestic credit costs (following Bank Indonesia's 175 basis points [bps] worth of interest rate hikes since June), slower economic growth, high inflation (8.3% year-on-year [y-o-y]) in October), and a weaker currency.

Recovery Not Yet Secured
Indonesia - Trade Balance, US$mn

The deterioration in the trade account from a surplus of US$22.4bn through the first nine months of 2011 to a deficit of US$6.2bn over the same period in 2013 has been the chief factor in the current account's dive into the red. Indeed, the current account's descent has been severe, with the deficit hitting a record 4.4% of GDP in Q213 versus a surplus of 0.6% just two years prior in Q211. While much of the imbalance can be chalked up to an overheating Indonesian economy (driven by record low interest rates amid overly dovish central bank policy), another major factor has been the rapid deterioration in the country's terms of trade. While prices across a number of major Indonesian imports (such as crude oil) have remained stable, this has not been the case for the country's exports. Coal, palm oil, and natural gas have been particularly hard hit, and these declines have undermined the total value of Indonesian outbound shipments even as import costs continued to rise.

Finally Some Good News?
Global - Newcastle Coal, US$/MT (LHS) & Generic Palm Oil, MYR/MT

Relief On The Way?

But relief may be coming on this front as well. Along with slowing demand for imports, the price outlook for key Indonesian exports is becoming more positive. In particular, coal and natural gas prices appear to have bottomed out (and have made solid gains over the past few months), and our commodities team is somewhat more sanguine on their prospects over the short to medium term.

Regaining Its Competitiveness
Indonesia - IDR Real Effective Exchange Rate

Meanwhile, broader indicators are also in the rupiah's favour. The rupiah's real effective exchange rate (REER) has corrected significantly since peaking in mid-2011, having fallen by 13.3% between August 2011 and October 2013, making Indonesian goods more competitive relative to those of their trading partners. Technically, a confirmation of bullish divergence on the relative strength index (RSI) would also signal an exhaustion in the rupiah's sell-off, suggesting near-term stability and potential for a recovery. Additionally, BI's foreign exchange reserves have recovered by US$4.3bn (4.7%) since hitting a nearly three-year low of US$92.7bn in July, suggesting that the central bank has not been forced to step in to support the rupiah as it has in the past. As a result of all of these factors, we are happy to retain our end-2013 forecast of IDR11,700/US$ on the unit, and expect the rupiah to average a slightly stronger IDR11,600/US$ in 2014 as the currency continues to stabilise amid a gradually improving current account situation.

Technical Turning Point?
Indonesia - Exchange Rate, IDR/US$ & RSI

Risks To Outlook

That said, there remain risks to the rupiah story. In particular, the currency has shown a high vulnerability to external financial market volatility, and could be at risk should EM assets suffer another sell-off as a result of Federal Reserve policy speculation in 2014. Furthermore, the currency bears risk to the general and presidential elections set for April and June of 2014, as policy uncertainty could take a toll on both foreign direct investment (FDI) and portfolio inflows.

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This article is tagged to:
Sector: Country Risk
Geography: Indonesia
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