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.