Rupiah gets election boost – but will it last?

This is what Indonesia needs to focus on

Indonesian's currency rallied nearly 5 percent against the U.S. dollar over the past three weeks in the run up to the country's presidential election, but analysts say strength is unlikely to last.

The rupiah strengthened to 11,500 against the dollar early Thursday, its strongest level since late May, amid reports Governor Joko Widodo led most unofficial vote counts, although his rival disputed these counts. Official results aren't expected until after July 20. Meanwhile, Indonesian stocks surged nearly 3 percent to a one-year high early Thursday.

Widodo - commonly called Jokowi - has a corruption-free reputation and is seen as the more market friendly candidate. Expectations for his victory have therefore boosted the nation's stock market and currency.

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"[We] expect short-term net positive impact on rupiah, but given the already sharp move in the past few days, some overshooting is not ruled out," said Helmi Arman of Citi Investment Research.

Citi said the currency's recent strength was unlikely to last, however, as attention turns back to the economy's worrying fundamentals.

"Under a six to 12 month horizon, we remain cautious given the rather slower-than-expected compression of the current account deficit," he added.

Read MoreIndonesia stocks surge to 1-year high post election

Indonesia's sizeable current account deficit - which currently stands at 3 percent of gross domestic product - was partly responsible for the rupiah's 21 percent decline against the dollar last year. Tackling the issue will be a key challenge for the new government.

Meanwhile, Ju Wang, Asian FX strategist at HSBC, told CNBC the rupiah could rise further on the likelihood of a Jokowi victory, but said the country's central bank would likely step in if strengthens much further.

Joko Widodo, Governor of Jakarta and presidential candidate.
Dimas Ardian | Bloomberg | Getty Images

"The government has said before their preferred range for the rupiah is between 11,500 and 12,000 [per dollar] and it's got closer to the stronger end of that range," said Wang.

"If the rupiah strengthens further, there is a highly likely probability that the Bank of Indonesia will do what the Reserve Bank of India did after the Indian election, which was to come into the market and buy U.S. dollars to build up reserves," added Wang, describing a policy move that would weaken the currency.

HSBC's Wang also referred to the rupiah's April high of 11,300 per dollar, prior to the country's legislative election, noting it would be challenging for the currency to return to that level.

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"Back then people were quite optimistic that Jokowi's party would have a large share of votes in the legislative election, which didn't happen. So the April level will serve as a peak because the current result is good but it's not as strong as people hoped before the legislative election," she said, adding that her forecast for the rupiah was 12,250 per dollar by year-end.

Indonesia carries out two separate elections to instate its government: the parliamentary elections which took place on 9 April this year to elect 136 members of the Regional Representative Council, and the presidential contest ongoing at the moment.

Jokowi's Indonesian Party of Struggle (PDI-P) won 18.9 percent of the vote in the legislative elections, but fell short of the 25 percent needed to allow him to run for president without a coalition, disappointing many investors. The PDI-P joined forces with the National Democrat (NasDem) party shortly afterwards, enabling Jokowi to run.

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Investors were nervous about the last-minute surge in support for ex-general Prabowo Subianto, whose reputation is tarnished by allegation of past human rights violations.