Rupiah plunge: It's not just commodities

ROMEO GACAD | AFP | Getty Images

A power struggle between Indonesian President Joko Widodo and members of his ruling party has become the latest catalyst for bearish sentiment on Southeast Asia's largest economy amid a protracted currency sell-off.

"Jokowi's management credibility has collapsed in the face of constant changes to the system," IMA Asia said in a recent report, referring to the President by his nickname.

Indeed, nine months since taking office, Jokowi continues to struggle with persistent opposition in parliament, impeding the progress of reforms, including the anti-corruption laws and state-driven infrastructure programs that he campaigned on.

"To start clearing such hurdles, Jokowi must reshuffle his cabinet, but whether that leads to a better or worse cabinet is the biggest political issue for 2015," IMA Asia said.

The uncertain outlook definitely has investors worried. The rupiah tumbled to 13,465 against the greenback on Monday, the seventh time in two months that it has traded at levels not seen since the Asian Financial Crisis in the late 1990s. It's lost 9 percent year-to-date, making it Asia's worst performing currency after the Malaysian ringgit.

"President Joko Widodo is still grappling to consolidate his position nearly a year since taking office. Failure to stabilize the coalition, pass legislation, and improve the investment environment could further undermine the near-term outlook for the economy," Deutsche Bank warned in a note last week.

But a cabinet reshuffle may be easier said than done.

Read MoreIndonesia's growth stumbles in first quarter

"Unlike former President Yudhoyono who dominated his political party, Jokowi had limited political space in composing his working cabinet, and is likely to have limited freedom in reshuffling it, too," Singapore's Nanyang Technological University (NTU) warned in a July note, noting that politician Megawati Soekarnoputri still holds the throne in the ruling Indonesia Democratic Party of Struggle (PDIP).

"Patronage thus becomes a prominent element in clinching the reshuffle," NTU said.

IMA Asia agreed, stating that Jokowi is under pressure to award the old guard leadership in his party their perceived entitlements via control over lucrative cabinet and administrative posts.

"There are rumors that the reshuffle may be politically motivated by the PDIP, in a move to increase its influence--recall that the cabinet is composed of technocrats and politicians," echoed Mizuho Bank economists.

Mizuho economists believe the reshuffle may be announced soon as Ramadan festivities are now over, adding that the primary reason behind the move is likely a decline in the President's approval rating to 40 percent, according to a survey earlier this month by Saiful Mujani Research and Consultant (SMRC).

Moreover, the President also needs to retain the loyalty of his coalition members by including their cadres in the cabinet, NTU said.

"Defection by anyone in his coalition camp will loosen his grip on parliament, so he may need to engage in a tradeoff between improving his cabinet and retaining the loyalty of a coalition partner," NTU said.

A myriad of issues

A prolonged rout in commodities is also deepening concerns about Indonesia's economic health.

Around 60 percent of Indonesia's exports are commodities, particularly coal, but a monthly thermal coal reference price published by the government—known as the HBA—showed July prices at $59.1 per ton, the lowest level since 2009. Moreover, Chinese demand continues to dwindle, with thermal coal imports from Indonesia slumping 52 percent on year in June, Platts reported last week.

That's eating into Jakarta's terms of trade. The central bank now expects the second quarter current account deficit at 2.3 percent of gross domestic product, from 1.8 percent in the first three months of the year.

Read MoreWhy this Indonesian property tycoon admires Singapore

Combined with spiking inflation—annual inflation has remained above 7 percent since May, the highest in Southeast Asia—the economy is on the back foot ahead of a looming U.S. interest rate hike later this year, which many analysts expect could lead to further outflows from the country.

But some aren't sure how big the impact will be.

Theoretically, a U.S. rate hike shouldn't have a big impact on the rupiah, according to the CEO of the country's largest bank by assets. "Even when pricing in a 75 basis point rate increase by the Federal Reserve, the spread between Indonesian and U.S. benchmark rates will likely be 675 basis points, just slightly higher than the historical average of 645 points," Budi Sadikin of Bank Mandiri told CNBC last week.

"But psychologically, there is a lot of fear. If we don't address that, more [currency] falls will happen."

Meanwhile, worries are also mounting about the government's latest protectionist measures. Jakarta recently raised import tariffs on a number of consumer goods, including food, which could add $59 billion to state coffers.

"The government's upward revision on import taxes for more than 1,000 items was somewhat puzzling," DBS said in a Monday note. "There has been a growing sentiment against the government's increasingly interventionist ways. A moderation in consumption growth has been apparent so far this year and the introduction of import taxes is not helpful in this regard."