Why Indonesia could be worse off than India

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The whipping boys of emerging Asian markets in recent times – Indonesia and India – have their fair share of problems, but analysts are singling out Southeast Asia's biggest economy as the one in a more precarious position.

While both countries have wide current account deficits, analysts argue that Indonesia's external situation is worse as the economy has moved quickly from a current account surplus just a couple of years ago into a hefty deficit.

Indonesia's current account deficit widened to 4.4 percent of gross domestic product (GDP), or $9.8 billion, in the second quarter, compared with 2.6 percent of GDP in the previous quarter. In 2011, it recorded a current account surplus of $1.7 billion.

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By contrast, India's improving current account deficit is expected to narrow considerably over the coming months led by a decline in non-oil imports and a rise in exports and remittance flows. Barclays forecasts the current account deficit will shrink to 3.7 percent of GDP, or $68.2 billion, from 4.8 percent last year.

"In Indonesia, on a 12-month basis, the current account deficit is actually increasing. Whereas in India, it is shrinking and we expect it to continue to narrow further," Krishna Hegde, head of Asia Credit Research at Barclays told CNBC.

Hegde pointed to the high level of foreign ownership in Indonesia's domestic bond markets, which makes its current account balance more vulnerable to a capital flight.

"Both current account deficits are funded to an extent by portfolio flows. While equity outflows are a risk for both countries - in the case of Indonesia, foreign investment in bond holdings is substantial," he said.

About 30 percent of Indonesia's onshore government debt is owned by foreigners, compared to 3 percent in India, which is among the lowest in Asia.

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Also, unlike India's economy, whose exports are likely to benefit from the plummeting rupee, Hegde said a significant portion of Indonesia's exports are dollar-denominated commodities, which will not benefit much from a weaker rupiah.

The prospect of a scaling back of U.S. monetary stimulus has battered both currencies in recent months, with the Indian rupee diving 17 percent in the last three months, and the Indonesian rupiah tumbling 13 percent in the same period.

"In India, currency depreciation is filtering into increased export volumes as is visible from the anecdotes we have seen from textiles and automobiles sector. We would expect to see the effect of the sharp depreciation in the rupee to translate into lower trade deficits after a couple of months," Hegde noted.

From a growth perspective, Robert Prior-Wandesforde, director for Asia economics at Credit Suisse, expects India's economy to begin recovering this year as Indonesia's slowdown deepens.

"India has been slowing for three years. That makes me more optimistic that it can start to recover earlier," said Prior-Wandesforde.

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India's growth slowed to a four-year low of 4.4 percent year-on-year between April and June, from 4.8 percent in the previous three months. Indonesia's economy expanded 5.8 percent during the same quarter, its slowest pace in nearly three years.

—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H