World Economy

Indonesia's currency is spiraling. It'll have to make sacrifices to save it

Key Points
  • The rupiah has been one of the worst-hit Asian currencies amid rising U.S. Treasury yields and strengthening in the dollar.
  • Indonesia's central bank announced an off-schedule meeting on May 30, increasing speculations that it will hike interest rates again to support the rupiah.
  • Indonesia increased interest rates just two weeks ago, so another rise so quickly would likely hurt growth, analysts said.
The entrance of Bank Indonesia, the central bank in Southeast Asia's largest economy.
Iqro Rinaldi | Reuters

Indonesia's rupiah has been growing worryingly weak, and the country's central bank has seen little success after multiple attempts to prop up the currency.

Now, Bank Indonesia said it will meet again on Wednesday — and speculation is rife that the central bank has more tricks up its sleeve.

The rupiah has been one of the worst-hit Asian currencies as investors pull out of the Indonesian stock and bond markets amid rising U.S. Treasury yields and strengthening in the greenback. The falling value of the rupiah could spell trouble for the country's large foreign currency debt, and the outflows from its bonds are bad news for its government.

The central bank tried to stem the currency weakness with measures including hiking interest rates and buying sovereign bonds, but the rupiah still depreciated: It fell to 14,202 per U.S. dollar on May 23. That was the weakest in more than two years.

Dollar-rupiah is Asia's 'weak link,' says portfolio manager
Dollar-rupiah is Asia's 'weak link,' says portfolio manager

With the persistent rupiah weakness, more "rate hikes may be needed, with the next one possibly as early as this week," Eugene Leow, a strategist at Singapore's DBS Bank, wrote in a Monday note.

The central bank hiked interest rates by 25 basis points in its mid-May meeting — the first raise since November 2014. Central bankers were scheduled to convene again in June, but Bank Indonesia last Friday said an additional policy meeting would be held on May 30.

Perry Warjiyo, the newly minted governor of Bank Indonesia, said the additional meeting wasn't an "emergency" but there's a need to be ahead of the curve given that the Federal Reserve is scheduled to review its policy on June 12 and 13.

"The dynamics offshore happen so quickly and market perceptions are formed quickly that there is a tendency that some became irrational. These dynamics need to be responded to immediately to stabilize things," Warjiyo said in a news conference on Monday.

Higher rates may hurt Indonesia's growth

Analysts, including those at Morgan Stanley, are expecting another 25-basis-point increase in Indonesia's interest rates this Wednesday. But some warned hiking rates again within such a short period may cripple the economy.

Australian lender ANZ Bank said Indonesia needs another two 25-basis-point hikes to support the rupiah. If the central bank does such an adjustment in the next two meetings on May 30 and June 27-28, the country will have increased interest rates by 75 basis points in just six weeks.

Why Indonesia is 'naturally on the back foot': Economist
Why Indonesia is 'naturally on the back foot': Economist

"Such an aggressive hiking cycle would weigh on growth," ANZ analysts wrote in a note on Monday, adding that a 100-basis-point increase in the policy rate could shave 0.2 to 0.4 percentage points off the country's annual growth.

"As such, we expect more macro prudential measures to partially offset the negative impact on growth. Already, the central bank is looking to relax the housing loan-to-value ratio," the analysts said.

Indonesia, the largest economy in Southeast Asia, has already seen growth disappoint: Its economy missed analyst expectations by growing only 5.06 percent in the first quarter of the year. Higher interest rates make lending more expensive, which can lead to lower spending by businesses and consumers — a further dampener on growth.

— Reuters contributed to this report.