Rupiah depreciation

Rupiah depreciation

Foreign exchange officials at several banks have noted a new wave of
dollar purchases in recent weeks due to the higher pace of the
depreciation of the rupiah. Although the buying has not reached the
point of "being a rush" to the greenback, some analysts have begun to
nurture wild speculations about the rupiah rate, thereby prompting a
number of depositors to move their accounts to the dollar position. The
situation has developed to the point that Dahlan Sutalaksana, the chief
of the money market at Bank Indonesia, felt it necessary to issue a
strong statement to kill rumors of an impending devaluation of the
rupiah.

The rumors of devaluation are irrational. Not only in view of the
repeated assurances from Minister of Finance Mar'ie Muhammad that the
government will not resort to what he called shocking policies, but also
judging from the fundamentals of the economy and the country's huge
foreign debts of about US$90 billion.

There is not a single reason at all for the government to take such a
drastic monetary measure because the fundamentals of the economy are
fairly sound, the foreign exchange reserves held by the central bank
exceeded $12.5 billion or the equivalent of five months of imports. The
downward trend in the international oil prices does cause some concern,
but oil now accounts for less than 30 percent of total export earnings.
And although non-oil exports also seem to have lost their robust
strength, a one-shot devaluation would not provide a significant boost
to export competitiveness. Instead, such a move would most likely cause
more damaging impacts across the economy.

We, therefore, tend to believe the finance minister's assurance that
the government will not devalue the rupiah but will rather, if
necessary, accelerate the rate of its depreciation to prevent it from
being overvalued. We take his statement to mean that the floating rate
of the rupiah will follow the concept of purchasing power parity. This
means that the exchange rate will tend towards the point at which its
international purchasing power is equal. Consequently, the rate will be
influenced, among other things, by Indonesia's inflation rate.

Set against this concept, we see the recent developments in the
rupiah rate and the shift by some depositors from rupiah to dollar
positions as normal and in accordance with the market trends. Obviously,
currencies will shift until domestic interest rates equal foreign
interest rates, plus the expected rate of change in the currency. So
when depositors saw a steady downward trend in both the rupiah deposit
rate and the rupiah exchange rate, with the inflation rate already
exceeding 3.70 percent in the first quarter, in sharp contrast to the
upward trend in the American interest rate, it was only logical for them
to move their accounts on to dollar position.

Moreover, depositors and investors expect the currencies to move at a
rate that is proportional to the discrepancy between the current
exchange rate and purchasing power parity. But because of the expected
higher rate of rupiah depreciation, they saw it as more profitable now
to hold dollar assets rather than rupiah accounts. Thus, the trend over
the last few weeks.