Another Indonesian Financial Crisis? Not Quite.

The Indonesian rupiah fell to 14,730 against the U.S. dollar on August 31, prompting Bank Indonesia to burn through $200 million in foreign currency reserves purchasing government bonds, something it has been doing regularly since the beginning of the year. There are reports that exporters are holding onto their dollars so they won’t get caught flat-footed if the currency weakens further, and yields on government bonds have been steadily inching upward. Several press reports have noted that the currency is closing in on its nadir from the Asian Financial Crisis of 1997-1998, when it hit 16,800 against the dollar, and the central bank has raised interest rates five times in recent months to try and stem capital outflows. The question many are asking is whether Indonesia is nearing the precipice of another crisis, similar to the currency flight from the late 1990s that ultimately toppled the Suharto regime.

While capital markets are tricky to predict, there are many important differences between today and 1997, not the least of which is the scale of the rupiah’s depreciation. During the Asian Financial Crisis, the rupiah fell from 2,000 to a low of 16,800 over the course of a few months, a decrease in value of 840 percent. By comparison, although in absolute terms the rupiah is pushing close to its crisis levels from two decades ago, it started from a much lower position and so doesn’t have nearly as far to fall. In relative terms, the currency has only shed about 9 percent since the beginning of the year and it has been a gradual decline. Noting that the rupiah is nearing its lowest level in 20 years is therefore a fairly superficial comparison, as the relative decline is nowhere near that of two decades ago.

Moreover, the rupiah’s weakening is in line with a broader overall trend in emerging market currencies, largely in response to the U.S. Federal Reserve’s decision to begin bumping up interest rates. That is to say, a lot of currencies are feeling the heat right now – this is not a uniquely Indonesian or even Asia-Pacific phenomenon. This is because when interest rates rise in the United States, investors typically reduce their exposure in emerging markets as they move funds back to U.S. assets, and this hits economies running current account deficits — like Indonesia — even harder as they have to borrow in foreign currencies to make up the difference. Argentina and Turkey’s currency woes have also likely made investors even more skittish about emerging market currencies like Indonesia’s.

From a macroeconomic perspective, the rupiah’s slide has not only been relatively gradual (especially compared to the Asian Financial Crisis) but also fairly predictable given the Fed’s monetary tightening. It is of course always possible that, human behavior being what it is, investors will panic and continue to sell off Indonesian assets, especially as the currency’s continued weakening becomes a sort of negative feedback loop, which can be hard to break out of. But from a big picture perspective the rupiah is just one of many currencies being squeezed, and one that is in reasonably good shape to defend itself, having started the year with over $130 billion in foreign exchange reserves for just such a contingency.

To improve its current account deficit, the government has announced it will curb imports. But in fact the balance of trade doesn’t look too bad, running a surplus in June before widening into a $2 billion deficit in July. In the second quarter of 2018, the country was running a current account deficit of about $8 billion, with surging imports in capital and consumer goods pushing the deficit higher. While this trade imbalance is putting pressure on the rupiah, it is also a sign that the economic fundamentals of the country are pretty solid. Strong demand for imported consumer goods suggests aggregate demand in the economy is healthy, while increased imports of heavy machinery and capital goods are a sign of investment in things that drive long-run economic growth, like infrastructure. Running a $2 billion trade deficit (which is only a tiny fraction of the country’s $1 trillion GDP) to meet strong consumer demand and investment in the bones of long-term growth is hardly unsound economic policy.

When it comes to debt, Indonesia is also looking pretty good, as there is a legal cap on how large of a deficit the government can run in any fiscal year – 3 percent of GDP. This policy came from many hard-learned lessons over the years of foreign creditors offering olive branches during good times that turned into crippling liabilities during down times. The upshot is that the government finally learned its lesson, and now generally keeps away from over-exposing itself to debt traps. With almost $120 billion remaining in foreign currency reserves and a low debt-to-GDP ratio, Indonesia’s public finances are in a pretty sound position to continue defending the currency.

The bigger concern is probably from debt incurred by state-owned companies. Over the last year, the government – limited as it is by the 3 percent cap on deficit-spending – has been pushing state-owned companies to take on more debt in order to share the burden of financing big-ticket infrastructure projects. One of the most vulnerable is state-owned utility company PLN, which just issued $2 billion in dollar-denominated bonds. In the last year or two they have also loaded up on debt from a variety of international banks and lending consortiums, earmarked for power plant development projects, and have billions of dollars in purchase agreements with independent plants that sell them power at a fixed rate.

Almost all of this debt and purchasing power is denominated in dollars, which is problematic as the utility’s revenue is paid in rupiah. Furthermore, the retail rates it charges customers have been frozen until the end of the 2019 election cycle, so in a crunch it’s going to be hard-pressed to raise funds from operations. In its own internal calculations, PLN assumes a 10 percent decrease in the currency as a “worst-case scenario” and maintains sufficient reserves for that eventuality. Yet the rupiah has already slid 9 percent with four months left in 2018, which naturally raises some questions about whether PLN is sufficiently capitalized to satisfy its expanding debt burden if the rupiah continues to weaken.

And in all likelihood, it will continue to weaken. The Fed is likely going to raise rates again later this year, and investors will continue to turn a wary eye on emerging market currencies like Indonesia’s. While government efforts to reduce the current account deficit might help alleviate some of the pressure, it won’t happen overnight. But even as the rupiah approaches its all-time low from two decades ago, it is important to note that the economic fundamentals this time around are very different.

The rupiah’s slide is being driven by rate hikes in the United States, and it is not alone as many emerging market currencies are finding themselves shedding value against the dollar. This time, the government’s finances are in much better shape, with modest debt and a large stockpile of foreign reserves to help smooth out the rupiah’s ride. Moreover, the current account deficit is in some ways a sign that the economy is experiencing healthy levels of consumer demand and investment in infrastructure and long-term economic assets. While state-owned companies like PLN might find themselves in a jam if the currency continues to fall, the overall picture of Indonesia’s economy is pretty good and comparisons between 2018 and 1998 don’t actually tell us very much.

Having said all that, if the rupiah continues to weaken it will surely be cause for worry to Indonesian President Joko “Jokowi” Widodo, who is up for re-election in April of next year. Whatever the reason for the currency’s decline, it will not be a good look for the incumbent president if the nation’s currency reaches levels that bring back memories of the Asian Financial Crisis, make imported goods pricier, and force big-ticket infrastructure projects to be shelved because foreign parts are too expensive. That is the kind of material tailor-made for attack ads, and even if the economy’s fundamentals are quite different from those of the late 1990s, a plunge in the currency right before the election might mean Jokowi ends up sharing the same fate as Suharto anyway.