Why an Emerging Market Rout Has Hit Indonesia So Hard

(Bloomberg) -- As a financial crisis in Turkey shakes global emerging markets, Indonesia is taking a bigger knock than its peers in Asia. The rupiah slumped to an almost three-year low against the dollar and stocks are being dumped. The central bank is selling billions of dollars from its reserves to halt the rout and has raised interest rates four times since mid-May.

1. What triggered the selloff?

Even before the Turkey crisis, emerging markets were under pressure because of rising U.S. interest rates and a stronger dollar. Part of the appeal of emerging markets is their relatively higher yields compared with developed markets. When that differential falls because of the U.S. Federal Reserve raising borrowing costs, emerging markets become less attractive. The turmoil in Turkey adds to emerging-market woes because it reduces investors’ appetite for risky assets and accelerates the movement of foreign capital from higher-yielding securities to relatively safer ones in developed markets.

2. Why is Indonesia being targeted?

It’s one of a few Asian emerging markets that runs current-account deficits (so do India and the Philippines), and recent data shows it widened to a four-year high. The deficit economies rely on foreign inflows to finance their import needs, making them vulnerable to a slump in sentiment and sharp outflows. Foreign investors own almost 40 percent of Indonesia’s government bonds, among the highest of Asian emerging markets. Add to that the government runs a budget deficit, meaning it needs to borrow to finance spending.

3. How badly are the currency and stocks faring?

The rupiah is the second-worst performer in Asia (after India) since the emerging-market selloff began in late January, weakening about 9 percent to its lowest level against the dollar since 2015. The Jakarta Stock Exchange Composite Index, or JCI, is down 9 percent this year, while the yield on the benchmark 10-year government bonds has rallied this year to the highest since the end of 2016.

Why an Emerging Market Rout Has Hit Indonesia So Hard

4. What has the central bank done to stem the rout?

Bank Indonesia raised interest rates by a total of 125 basis points since May and intervened in both the currency and the bond market to curb losses, draining what was a record stockpile of foreign reserves in January by about $14 billion to $118 billion in July. The central bank has said it stands ready to respond to excessive market volatility and has maintained a hawkish monetary policy. Ahead of this year’s fourth rate hike on Aug. 15, authorities said they were already intervening in the foreign-exchange market to stabilize the currency and injecting more liquidity through swap auctions. The government is doing its bit to shore up dollar supplies, too: It plans to restrict imports of consumer goods, accelerate the use of palm-based biodiesel to cut fuel imports, promote tourism and boost exports. It also intends to order its main energy company to be the sole buyer of locally produced crude to help reduce oil imports.

5. Will it succeed?

The central bank says Indonesia’s economic fundamentals are better than many emerging market counterparts such as Argentina, Turkey and Russia, while analysts point to a generally stronger position for Asian emerging markets that makes them able to withstand external shocks better than global peers. But with the Fed set to continue raising interest rates and the spread between U.S. and emerging market yields narrowing, expect more currency weakness, which will only get worse if the slump in the Turkish lira continues.

6. Hasn’t this happened before?

In the so-called “taper tantrum” of 2013, when the Fed first raised the idea of withdrawing stimulus, the rupiah was one of the hardest-hit currencies in Asia, dropping more than 25 percent against the dollar that year. Finance Minister Sri Mulyani Indrawati has been at pains to point out the economy is in a stronger position than it was in 2013, given bigger foreign reserves and lower inflation. Indeed, Moody’s Investors Service upgraded Indonesia in April citing steps taken to improve the economy’s resilience to global shocks.

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