Indonesia's currency slides as emerging markets sell off

The emerging markets sell-off has pushed the Indonesian rupiah to its weakest level against the dollar since the 1998 Asian crisis. This year thecurrency has shed 9%.Indonesia has "a history of volatile inflation and currency moves", notes Reuters. Its current fragility comes from a mix of longstanding and new factors. The current-account deficit has widened "worryingly". In the second quarter of the year, it amounted to about $8bn. The central bank expects it to grow from last year's 1.7% to 2.5% of GDP in 2018.

Emerging-market investors are always rattled by external deficits, since they require filling by foreign capital and higher US interest rates are drawing capital away from traditionally risky assets such as emerging markets. Meanwhile, Indonesia exports commodities such as natural gas, rice, palm oil, tin and copper, so its fortunes can fluctuate in line with volatile raw materials prices.

Staying cool in a crisis

"Indonesia's best defence of its currency may be a cool head," says Clara Ferreira-Marques on Breakingviews. Jakarta is now better placed to defend the rupiah than it was two decades ago. That's because its foreign-exchange reserves are bigger and its external debt, at 20% of GDP, is lower than in more vulnerable emerging markets such as Turkey or Argentina. The Bank of Indonesia has also sensibly raised interest rates four times since May to bolster the currency.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Sign up

One key risk in the country is the recent rise of Islamist politics, which is threatening to undermine the country's civil liberties, says Yaroslav Trofimov in The Wall Street Journal. Almost 90% of the 270-million-strong population are Muslim. There is also widespread animosity against the country's ethnic Chinese minority, which plays "an outsize role in the country's economy". Next year, presidential elections are looming, so investors will continue to keep a wary eye on the political backdrop.

In the long run, though, Indonesia's economy has the potential to do well. As the trade dispute between the US and China threatens to unsettle the global economy, Indonesia may be cushioned by its large domestic market and promising demographics. It is less reliant on exports compared with other countries in southeast Asia, as consumption accounts for more than half of its GDP.

A good long-term fix for the economy "would be continued liberalisation and stable policies that help attract cash", says Ferreira-Marques. For instance, delaying $25bn of power-plant investments was not a good move, as it hampers efforts to improve infrastructure. "Without these upgrades, Indonesia might struggle to make itself a choice destination for foreign money."