The Indonesian Rupiah in the Quagmire

As the largest economy in Southeast Asia, Indonesia's Jakarta Composite Index has dropped 29% since the beginning of this year, and the Indonesian Rupiah has depreciated by more than 6% against the US dollar. Facing the so-called "triple slay" of stocks, bonds, and currency, Indonesia has experienced a "defense of the emerging markets" crisis in the past six months. In January this year, MSCI announced a freeze on all index rebalancing for Indonesia, no longer adding Indonesian stocks to the emerging markets index, and issued a heavy warning: there are fundamental investability flaws in the Indonesian market. If reforms are not made within a set period, Indonesia will be downgraded from the emerging markets to the frontier markets.

Last week, MSCI’s final decision was to maintain the rating but downgrade the “information flow” sub-rating to negative. Within less than a month, the Indonesian central bank raised rates by 100 basis points, leading to the Rupiah bouncing from historical lows. Is the crisis truly over? 

Fiscal deficit remains high, exchange rate under pressure.Indonesia’s “State Budget Law” strictly caps the fiscal deficit ratio at 3% and government debt ratio at 60%. In 2025, Indonesia’s fiscal deficit ratio is set to rise to a post-pandemic high (the cap was temporarily lifted during the pandemic), and following the US-Iran conflict, international oil prices rose, forcing an increase in fuel subsidies while simultaneously advancing nationwide nutrition programs and infrastructure. With persistently high fiscal expenditure and sluggish revenue growth, the market has doubts about the current balance and sustainability of Indonesia’s finances.

Net oil imports have weighed on the exchange rate since the US-Iran conflict.In comparison, both Brazil and Indonesia are major commodity-exporting emerging economies, yet their currencies have diverged. Looking at the trade structures, Brazil relies on deepwater oil technology, becoming a net exporter of crude oil, while Indonesia’s trade surplus is mainly due to coal, palm oil, and ferronickel alloys, but its oil and gas segment is in natural deficit and largely dependent on imports. The divergence between the two countries’ currencies has grown since oil prices rose amid the US-Iran conflict.

In the article "Asian Currency Defense War", we have already introduced how, since the beginning of this year, Bank Indonesia has directly intervened through foreign exchange reserves and implemented various macro-prudential and capital control measures. Combined with a series of interest rate hikes since May, these have allowed the Rupiah some respite, but the fundamental reasons for its weakness remain unchanged:

(1) Expansion of the fiscal deficit and persistently high deficit ratio mean that rate hikes and currency depreciation are likely to continue increasing fiscal pressures;

(2) The newly introduced strategic resource state-owned enterprise export monopoly policy (controlling coal, palm oil, titanium alloys, etc. through companies under the sovereign wealth fund as the sole legal export agents to foreign buyers) is intended to boost fiscal revenue but is controversial in the market and may hamper exports. Coupled with Indonesia’s long-standing net energy imports, trade uncertainties are on the rise.