Breaking the myth on the Indonesian Rupiah
During his fit and proper test for the position of Senior Deputy Governor of Bank Indonesia, Mirza Adityaswara commented that the Indonesian rupiah (IDR) weakening may not necessarily be negative for the country’s economy while an appreciation in the currency may not necessarily be positive either. Such a thought may be foreign to most Indonesians, who are mostly completely averse towards any weakening of the IDR. The inaccurate conventional myth that sees IDR weakening as a taboo may be driven by the fact that the currency has had a tendency to weaken in the past few decades, causing society to long for appreciation. However, the notion may be more acceptable in recent years as, globally, countries are seeking out more competitive currencies to revive growth.
The following simple example seeks to illustrate the logic behind currency movement. Assuming for argument’s sake, a current conversion of USD 1 is Rp 10,000. Let us assume that it costs Rp 10,000 for Indonesia to produce a book, while the same item is produced in United States at USD 1. Accordingly, assume that Indonesia’s inflation rate for the year stood at 10% while it was 0% for the United States (US). Thus, a year down the road, it costs Indonesia Rp 11,000 to produce the same item but remains USD 1 for the US. In this scenario, Indonesia’s currency should weaken initially from USD 1 = Rp 10,000 to USD 1= Rp 11,000. Failure to weaken its currency will cause Indonesia to be less competitive and indeed, the weakening of IDR is necessary.
There has also been a misconception that excessive weakening of IDR was the culprit behind the country’s economic crisis in 1997-1998. While the rapid weakening of IDR certainly disrupted the country’s economy, the real culprit was the fact that the currency was well over-valued previously. Indeed, never in the world’s history has a nation entered into recession due to an undervalued currency, but most crises have been sparked by having an overvalued currency. An overvalued currency hikes imports and curbs exports, leading to a trade deficit, while at the same time it also increases the attractiveness of foreign borrowing, inducing the risk of over-leveraging. These were the key factors that drove Indonesia into the 1997 Asian Financial Crisis.
Recognizing the risks associated with an overvalued currency, in recent months, we have seen the Indonesian central bank defending its currency, not to prevent it from weakening as many may have suspected, but rather to avoid excessive strengthening of IDR. Such a move should be commended as Indonesia has historically fallen prey to hot money flows. Due to increasing global liquidity on the back of successive Quantitative Easing programs by the US, we saw the IDR strengthen from the Rp 10,000 level per USD 1 to reach Rp 8,500 per USD 1. However, in recent years, as liquidity returned to developed markets, IDR weakened from Rp 8,500 per USD 1 to around Rp 13,000-Rp 13,500 per USD 1 currently.
Aiming for stability
Indeed, it may be said that some of the weakening in Indonesia’s purchasing power may be ascribed to IDR’s depreciation. In the past four years, Indonesia’s GDP per capita, in USD terms, has been on a continuous decline. While most goods are transacted using IDR domestically, there remain import components which are priced in foreign currencies. Therefore, while we are not proponents for an overvalued IDR, neither do we believe in an undervalued currency as it threatens purchasing power. As such, the most preferred condition would be for a stable currency. That is, depending on the development of Indonesia’s macroeconomics, its currency should move from one equilibrium level to the next in a manner that is gradual enough.
The challenge is to define the notion of a ‘stable currency’. In today’s world, most currencies globally are benchmarked against the USD. However, such a tendency will create a misconception of currency depreciation during the period where the USD strengthens relative to its global peers. After all, most countries, Indonesia included, trades with multiple nations outside the US and thus, solely benchmarking its currency to USD is not theoretically accurate, although we do recognize the simplicity appeal of such an approach. In order to avoid unnecessary public misconception, we believe that there may be a need for Bank Indonesia to start publishing an IDR index, similar to the US Dollar Index (DXY), which measures IDR relative to currencies of global peers.
In summary, we believe it may be dangerous to have a preset perception favoring the IDR to either strengthen or weaken. Indeed, we concur with the notion that IDR weakening may not necessarily be perceived as negative while the reverse may not necessarily be positive. The level of the IDR should be evaluated based on the country’s macroeconomic standing relative to its peers. We commend Bank Indonesia’s target to maintain stability of IDR, namely preventing excessive volatility of the currency. However, while showing the practical appeal, solely benchmarking IDR to the USD may create misperceptions and thus, there may be a need for wider recognition towards the use of an IDR index relative to currencies of its global peers.
The views and opinions contained herein are those of Teddy Oetomo, Head of Intermediary, and Renny Rahardja, Intermediary Business, and may not necessarily represent views expressed or reflected by PT Schroder Investment Management Indonesia (“Schroders Indonesia”) view. For professional investors and advisers only. This document is not suitable for retail clients. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders Indonesia does not warrant its completeness or accuracy. This does not exclude or restrict any duty or liability that Schroders Indonesia has to its customers under Indonesian laws and regulations.”
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