Is Indonesia Facing a Currency Collapse?

Indonesia has hiked its key interest rate by 0.75% to "a two-year high" of 9.5%, says Bloomberg, to "halt a plunge" in its currency, the Indonesian rupiah. The higher rates are meant to "stem the flow of capital out of the nation", which saw the currency fall by as much as 15% against the dollar in the past three weeks.

State subsidies of fuel prices are behind the problem. Indonesia is the only member of oil cartel Opec which is a net oil importer, and the recent surge in oil prices has pushed up the cost of government hand-outs.

This "penchant for subsidising fuel" is set to cost the country $14bn during 2005, a third of its expected spending, says Lex in the FT. President Susilo Bambang Yudhoyono managed to push through a cut in subsidies in March, which saw average fuel prices rise by 29%. But the rise in crude "has more than wiped out any savings". Indonesia's foreign exchange reserves fell by about $4bn to $32bn in the first six months of this year, to pay for "imported oil and to shore up its currency".

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The hike in rates has stabilised the currency for the time being. But the country's "daunting economic and social problems have not yet been resolved", says Edward Hadas on Breakingviews.com.

Increased foreign investment would help staunch the flow of dollars leaving the country, and could eventually raise export revenues by pumping money into oil and gas production. "But weak institutions and internal political discord" have put foreigners off.

More fuel subsidy cuts would also help, "but the issue is politically sensitive", with voters sceptical that the saved money will be used "for their benefit" in a country where official corruption is a "tradition".

With inflation at 8%, the currency still looks vulnerable, and lower subsidies would push up inflation in the form of higher fuel prices. "Yudhoyono has his work cut out for him"