Analysis: Indonesia’s defenses begin to crumble against the relentless dollar

SINGAPORE (Reuters) – The Indonesian currency is falling and foreign money in bond markets is heading out, raising fears that Southeast Asia’s largest economy is finally beginning to collapse after months of perceived resilience in the face of global headwinds.

Despite its history of ruthless market beatings during times of global economic stress, Indonesia was surprisingly outperforming until August, buoyed in large part by its exports of gas, palm oil and other valuable commodities.

Stock market (.JKSE) It is the best performer in Asia this year, with the rupee depreciating just 3% in the six months to the end of August against the strong US dollar, while the South Korean won and Thai baht both fell more than 10%.

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But September brought a turn for the worse as the rupee plunged 2.5%, its biggest monthly decline this year and more in line with its Asian peers, prompting analysts and investors to sound the alarm about risks old and familiar: dwindling currency reserves, mounting debt. Obligations and the flight of foreign capital.

It’s kind of catch-up, or catch-up,” said Galvin Shea, emerging markets analyst at NatWest Markets. He blamed the currency’s falter on volatile external factors, including the dollar’s continued rise.

But market experts say this time will be different, as Indonesia’s strong economy and monetary policy will help it withstand the kind of beating it has endured in past crises.

“You still have a reasonable load, you still have a central bank, now at least, it’s more active, you have a lot of credibility, and you still have a tailwind from commodities,” said Ihab Salib, senior portfolio manager and head of international services. Fixed Income Group at Federated Hermes.

“I think all of those together, to me, suggest that perhaps Indonesia is outperforming on a relative basis.”

The historical weakness of the rupiah is due to its status as a risky but high-return “portable” trade, which attracted high foreign ownership of Indonesian bonds when returns in more developed markets offered relatively low returns.

During the Fed’s previous tightening cycle in 2018, the rupee fell to multi-decade lows. During the 2013 “taper tantrum”, it decreased by 20%.

Down rupee

But higher commodity prices have been a mainstay this year, with a widening current account surplus providing protection against capital outflows. Foreign ownership of Indonesian bonds, which accounted for half of the market a decade ago, is also lower, around 14%.

However, Indonesia’s yield advantage is evaporating as prices elsewhere rise faster. Outflows from the bond market, with yields of 7%, reached $11 billion in the first three quarters of 2022, nearly double the $5.7 billion for all of 2021.

“I think it’s more of a belated reaction,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank, regarding the recent decline in the rupee.

“There are some exceptional factors, but none of them provide this kind of panacea for the remaining underlying risks.”

With no indications that the dollar’s rally will peak anytime soon, Varathan highlights the risks that Indonesia’s external debt obligations and declining currency reserves will become a concern at the same time that domestic policy tightening is affecting growth.

“If these things start to conspire… we could have a very sudden episode of capital outflows.”

Indonesia’s foreign exchange reserves fell by $1.4 billion last month to $130.8 billion, due to debt payments and Bank Indonesia’s efforts to stabilize the rupiah. Read more

September data also showed Indonesia’s inflation rose to a seven-year high, reflecting a jump in fuel prices.

However, the stock market remains a bright spot, as investors are betting that the prices of oil and other resources that Indonesia exports will remain high. The Jakarta benchmark, which is up more than 3% year-to-date at Friday’s close, is among only a handful of gains this year, alongside Brazil’s Bovespa. (.BVSP) Which is approximately 7%.

Bank Indonesia, which until recently was one of the world’s hawkish central banks and raised concerns about inflation complacency, reassured markets last month with a surprise 50 basis point interest rate hike, which it described as a precautionary measure to rein in inflation expectations.

“Indonesia remains a very good story in Asian portfolios,” said Rajat Agarwal, Asian equities strategist at Societe Generale SA.

“If you look at consumption, look at credit growth, it’s all local, unlike other export markets in Asia. Indonesia will be one of the most resilient markets in the current background.”

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Additional reporting by Ray Wei in Singapore and Sam Zhen in Hong Kong; Additional reporting by Baturja Murugaupathi in Bangalore. Editing by Vidya Ranganathan and Edmund Kelman

Our criteria: Thomson Reuters Trust Principles.

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