Shotaro Tani, Tokyo – Indonesia's central bank has its hands tied by a slide in the rupiah.
Bank Indonesia on Tuesday kept its benchmark policy rate on hold for the second straight monetary policy meeting. The central bank's seven-day reverse repo rate of 3.5% is its lowest since at least 2016 when it began using the rate as its benchmark.
The decision comes despite the central bank forecasting a weaker Indonesian economy amid a stronger-than-expected global recovery – the bank lowered Indonesia's growth forecast for this year to 4.1%-5.1% from the previous 4.3%-5.3%. Private consumption, which makes up over half of Indonesia's GDP, "is not as high as initially thought," Perry Warjiyo, Bank Indonesia governor, said in an online press conference.
The weakening currency offers an explanation to why BI stood pat.
The rupiah has weakened 3.5% against the U.S. dollar since the end of 2020, making it the second worst performing currency among the first five members of the original Association of Southeast Asian Nations – Thailand, Indonesia, Singapore, the Philippines and Malaysia. In early April, the rupiah fell to its lowest level against the greenback in five months, according to FactSet data.
Only the Thai baht, which has fallen 3.9% so far this year against the U.S. dollar, has performed worse than the rupiah this year. The Malaysian ringgit, Filipino peso and Singapore dollar are holding up better with falls of 2.6%, 0.8% and 0.7%, respectively.
Most of the slide in Southeast Asian currencies can be explained by the U.S. dollar's strength. Interest rates in the U.S. have been trending higher amid speculation that the U.S. Federal Reserve may hike interest rates earlier than expected as President Joe Biden's stimulus package is expected to accelerate inflation. That has led investors to move back to U.S. assets and away from riskier-but-higher-return emerging assets in countries such as Indonesia.
For Indonesia, such moves by investors have an outsized influence on the currency market, as foreigners hold a fifth of the country's government bonds. Foreign investors held 987.3 trillion rupiah (about $68 billion) worth of government debt in January, but that fell 3.64% to 951.4 trillion rupiah in March.
"What we are facing is increasing and still high uncertainty on global financial markets," Warjiyo said. "The impact on us is that if global interest rates increase, of course, domestic adjustments will be needed," he added.
Speculation that the U.S. would further tighten monetary policy and the slides in Southeast Asian currencies initially prompted market debates on whether there will be another "taper tantrum" – market turmoil in 2013 caused by the expectation of Fed tightening that led to a large sell off in emerging market assets.
"As we enter Q2, we think the risk to U.S. yields is still to the upside amidst expectations for strong U.S. data," analysts at investment bank Goldman Sachs wrote in a note in early April. "Given the backdrop of likely higher U.S. yields and potentially firmer USD (against rate sensitive markets) in the near-term, we think the Indonesia local market should continue to underperform [Asia excluding Japan] FX peers."
However, the market "does not see the rupiah testing the 20-year low mark again," said one currency trader, noting the level currency reached last year as COVID-19 cases were rising. The trader noted that some economic indicators like the country's continued trade surplus is supporting the currency.
"But some market participants are worrying about the future of Bank Indonesia's independence," the trader said, referring to proposals to amend the law governing the central bank that has been simmering in the background.
Details are yet to be decided, but one plan being mooted is for Bank Indonesia to add economic growth and job creation to its mandate, on top of its current one of maintaining rupiah stability. The debate last year included talks of increasing government oversight of the central bank.
President Joko Widodo recently told Bloomberg in an interview that he supported plans to add mandates to the central bank, but said that Bank Indonesia will remain independent.
Nevertheless, talk about changing to the central bank law is "triggering concerns over its independence to maintain rupiah exchange rate stability," the trader said.