Indonesian Rupiah - Photo Privacy

JAKARTA (TheInsiderStories) – Last Tuesday, Indonesia’s (Baa2 stable) government bond spiked by nearly 30 basis points to 7.3 percent, but retreated to 7.2 percent at the end of the week, while the currency, the rupiah, extended its decline for the third consecutive month in May, depreciating 4.1 percent since the start of this year.

Anushka Shah, Vice President – Senior Analyst, Sovereign Risk Group, Moody’s Investors Service judging these market developments will have a credit-negative effect on the government’s fiscal metrics and weigh on debt affordability.

Currency depreciation raises the risk of higher imported inflation, and because the currency declines reflect outflows of portfolio capital, they may signal underlying balance-of-payment challenges through a drop in foreign-reserve buffers.

The market challenges reflect a stronger U.S dollar, higher oil prices and lackluster domestic economic growth. Although some of these factors are structural credit weaknesses specific to Indonesia, others affect many emerging markets.

Waning appetite for emerging markets is evident in a broad-based moderation of capital flows: according to the Institute for International Finance, net portfolio debt inflows to all emerging markets totaled US$39.6 billion between January and April this year, about half the inflows of the year-earlier period.

In Indonesia, net debt inflows year to date through April have slowed to less than $1 billion from $6.0 billion a year earlier, the result of rising U.S bond yields and a stronger dollar.

Indonesia-specific structural credit constraints include economic growth performance that while stronger than the 3.3 percent median for Baa-rated sovereigns has been slow to pick up from year-on-year average growth of 5.1% over the past five years, despite accommodative monetary policy and the government’s focus on infrastructure investment.

As a net oil importer, Indonesia is also vulnerable to oil-price volatility, which has been exacerbated by the US withdrawal from the Iran nuclear deal. As parliamentary elections, scheduled for 2019, draw closer, announcements freezing electricity and diesel prices point to a temporary reversal of some reform measures, which would increase the burden on the state-owned oil companies.

Indonesia’s central bank has intervened to quell rupiah depreciation, driving a moderation in foreign exchange reserves over the past three months. Additionally, the central bank has referred to its existing second line of defense, which entails ensuring support from other external institutions, including under the Chiang Mai Initiative Multilateralization, a multi-currency swap arrangement between the ASEAN +3 economies.9 It also stated that it would resort to policy rate tightening if necessary.

Continued central bank intervention to stem the currency depreciation would reduce foreign-reserve buffers, although the reduction so far as not been large. This, accompanied by portfolio outflows, would negatively affect Indonesia’s overall balance-of-payments position.

To be sure, current rupiah depreciation is much less than the 31.6 percent decline between May and December 2013, but if the negative exchange rate pressure were to persist, there would be implications throughout Indonesia’s economy.

Because the country had a high ratio of foreign currency debt to total general government debt of 40.1 percent at the end of 2017, further currency depreciation and rising yields would diminish debt affordability, which we measure as the ratio of interest payments to revenue or GDP.

Owing to a low revenue base, Indonesia’s ratio of interest payments to revenue of 11.7 percent is already weaker than the 8.2 percent median for Baa-rated sovereigns. Additionally, Indonesia has a high share of imported inflation, particularly from oil imports (fuel, electricity and water account for more than 5 percent of the consumer price index).

Currency declines would add to those pressures, disrupting the broader price stability of the past three consecutive years.

Continued central bank intervention to stem the currency depreciation would reduce foreign-reserve buffers, although the reduction so far as not been large. This, accompanied by portfolio outflows, would negatively affect Indonesia’s overall balance-of-payments position.

Email: linda.silaen@theinsiderstories.com

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The Insider Stories Founder Linda Silaen has a solid, proven history, established over more than a decade as a journalist with a leading internasional news organization, of being the first with the biggest economic news stories in Indonesia. Specializing in corporate news, Linda is also a veteran of some of the biggest macroeconomic and general news stories as Indonesia rapidly transforms into a major market economy. One of the founders of the original blog from which this company developed, Linda’s knowledge of investors’ information communications and data us developed from unrivaled networking skills that make her a well-known name among CEOs, bankers, government officials and private equity investors both in Indonesia and other countries.

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