USD/IDR: Markets continue to test BI’s resolve

Key Points

 

 

• The USD/IDR has broken the 16,300 level convincingly on the back of large domestic non-deliverable forward (DNDF) maturity and perhaps partly on concerns about the fiscal plans proposed by incoming President Prabowo to raise the government debt level to 50% of GDP from 39% in 2023. Equity and bond outflows have persisted, with the Jakarta composite index falling nearly 10% since its mid-March peak, while 10y yield has risen by 10bps to 7.09% at the time of writing, which is the highest since early May (Chart 1).

• We have been cautious about the rupiah for quite some time, but today’s sharp depreciatory move has surprised us, partly as this has happened against the backdrop of a pullback in US yields (Chart 2) and only very modest US dollar strength over recent trading sessions. Moreover, implied rupiah volality is lower today compared to the mid-April high. Prabowo’s expansionary fiscal plan is nothing new to markets either, since he has earlier pledged to increase spending to finance his populist plan to provide free lunches for children, among others, which could cost the government as much as IDR460tn (US$28bn) a year.

• Markets could have continued to price in a higher domestic risk premium for the rupiah as political transition to a new President is only 4 months away. There’s risk regarding the forming of a governing coalition and key cabinet appointment, particularly who will succeed finance minister Sri Mulyani, who has been credited by foreign investors for her shrewd management of public finance. The PDI-P has not stated whether it will support Prabowo’s administration, and it could opt to be in the opposition camp. With PDI-P winning the most seats in the February legislative election, it may pose a hurdle to Prabowo’s policymaking.
• With Indonesia’s current account also no longer in surplus, the rupiah is susceptible to global pressures. To be fair, Bank Indonesia has reacted quickly to rupiah weakness by intervening in the FX market, raising the policy rate twice in October 2023 and in April, and launching rupiah securities (SRBI) to retain capital and attract foreign inflows. Yet, markets continue to test the BI’s resolve. As such, we have become more cautious about the rupiah, revising up our USDIDR forecast to 16,420 in Q3 from 15,900 previously, and to 16360 in Q4 from 15700 previously. The modest IDR strength in Q4 is in anticipation of the Fed cutting rates once while the BI keeps rates at 6.25%.
• The risk of a BI-rate hike in the upcoming policy meeting on 20 June has increased. We think the likelihood of another 25bps rate hike is high, especially if the rupiah falls to 16,450 per US dollar in the coming week, representing about a 2.9% drop since the last BI meeting. During the April hike, the rupiah fell by 2.9% following the March meeting (Chart 3). The surprise BI hike back in October 2023 also came on the heels of a 3% drop in the rupiah compared to the levels seen in the preceding meeting in September.