Is Indonesia Facing a Currency Collapse?

published 24 May 2006

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".

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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"

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.