Indonesian Rupiah (IDR) - August 2016

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Following the UK’s shock Brexit vote we now do not expect the Federal Reserve to hike interest rates until December, while almost every other G10 central banks remain overwhelmingly in easing mode. However, after the strength seen in the last two US labour market reports, we think that the risk to our Fed hiking forecasts are to the upside and it's now far more likely that we’ll see two hikes in 2016 than none at all.

By contrast, the Bank of England cut interest rates for the first time in nine years in August, with the European Central Bank looking likely to expand its quantitative easing measures later in 2016. Further, the Bank of Japan announced a modest expansion of its monetary stimulus program, while the Japanese Government will significantly expand stimulus spending.

We think that the backdrop of extraordinarily stimulative policy from the main central banks, with the notable exception of the Federal Reserve, and a clear shift towards more accommodative policies in the laggard economies (e.g. Japan) is generally positive for risk assets and emerging market currencies in particular.

The Indonesian Rupiah (IDR) has stabilised against the US Dollar after the devaluation of the Chinese Yuan in August last year led to a violent sell-off in the currency. The Rupiah plunged to its weakest position in seventeen years, although has since recovered well following intervention from the Bank Indonesia and a general depreciation of the US Dollar (Figure 1).

 

Figure 1: Historical Evolution of USD/IDR (2011 – 2016)

 

Source: Thomson Reuters Datastream Date: 09/08/2016

 

The relatively impressive performance in the Rupiah has come despite monetary easing from Bank Indonesia which unexpectedly lowered its benchmark interest rate again in June. Rates were lowered by 25 basis points to 6.5% in a bid to boost economic growth, increase inflation and take advantage of a stabilisation in the Rupiah. However, in July the Bank confounded expectations for a cut and kept rates unchanged, which has further contributed to IDR strength recently.

An over reliance on the production of coal, metal and rubber, which account for around 60% of overall exports, contributed to a modest slowdown in growth earlier in the year. However, second quarter numbers largely made up for this weakness. Strong Government spending, driven by public capital investment expenditures, pushed the economy back above the 5.0% level on an annualised basis.

Despite the series of interest rate cuts in Indonesia, real interest rates remain firmly positive and in excess of 3% following a sharp decrease in inflation (Figure 2). Headline consumer price growth has fallen sharply since the back end of last year, registering 3.5% in June. This is now finally back within the central bank’s 3-5% inflation target and should allow room for further easing in monetary policy in the coming months, especially after parliament passed a tax amnesty in June that could lead to 560 trillion Rupiah of inflows. However, we think that the rebound in growth means that any cuts will have to wait until the end of the year.

 

Figure 2: Indonesia Interest Rate vs. Inflation (2011 – 2016)

Source: Thomson Reuters Datastream Date: 09/08/2016

 

Further, Bank Indonesia has accumulated a relatively large chest of foreign exchange reserves which, at currently around 9 months’ worth of import cover (Figure 3), should be sufficient in order to allow the central bank to continue intervening in order to protect the Rupiah. The central bank intervened heavily last year in order to reverse the sharp depreciation in the currency.

 

Figure 3: Indonesia Foreign Exchange Reserves (US$ millions) (2006 – 2016)

Source: Thomson Reuters Datastream Date: 09/08/2016

 

The backdrop has turned unequivocally bullish for the Indonesian Rupiah, and we are revising our forecasts accordingly. Ample FX reserves, solidly positive real rates, manageable budget and current account deficits and strong growth on the back of decisive Government infrastructure plans will favour the Rupiah against most major currencies, while it holds its own against the US Dollar and Sterling.

By contrast, the large scale monetary easing measures from the European Central Bank in the Eurozone would, in our view, lead to a sharp appreciation of IDR against the Euro.

 

 

   

USD/IDR

EUR/IDR

GBP/IDR

Q3-2016

 

13,400

13,950

17,420

E-2016

13,300

12,900

17,200

Q1-2017

 

13,200

12,670

17,125

Q2-2017

13,200

12,540

17,180

E-2017

13,000

12,350

16,900

 

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