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HomeFOREXIndonesia Faces Policy Dilemma Amid Plummeting Rupiah
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Indonesia Faces Policy Dilemma Amid Plummeting Rupiah

Indonesia’s economic outlook, previously pointing towards potential monetary easing, has encountered complications due to a sharp decline in its currency, the rupiah. This unexpected turn of events is prompting discussions within Bank Indonesia (BI) about the possibility of raising interest rates sooner than anticipated, possibly as early as the upcoming policy review next week.

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The rupiah’s recent slump to a four-year low against the dollar, exacerbated by expectations of prolonged higher rates in the United States, has raised concerns among market participants. With a year-to-date loss of 5.25%, some are speculating that BI might resort to drastic measures such as a rate hike to stabilize the currency.

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Unlike other central banks, BI’s primary mandate is to ensure currency stability. While it has employed various intervention measures to manage the rupiah’s volatility, including direct intervention in the foreign exchange and domestic non-deliverable forwards (DNDF) markets, as well as bond purchases, the effectiveness of these measures is diminishing.

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The decline in Indonesia’s high-yielding bond market, once attractive for carry-trade investors, further complicates the situation. With narrowing spreads over dollar markets and heightened currency volatility, foreign investors have reduced their exposure to Indonesian government securities.

BI’s interventions have prevented the rupiah from depreciating as sharply as some of its counterparts, but with limited success. Despite spending approximately $6 billion in the first quarter alone, the central bank’s foreign exchange reserves remain under pressure.

Looking ahead, BI may find itself running out of options, especially as expectations for Fed rate cuts diminish. Some investors are shifting towards dollar-denominated bonds issued by Indonesian state firms, preferring them over rupiah assets.

While the possibility of Fed rate cuts later in the year could provide some relief for the rupiah, uncertainties persist. Investors remain cautious amid a sluggish Fed, with expectations for BI’s rate cuts pushed back to December from June.

The decision to potentially hike rates in response to currency depreciation would be a delicate balancing act for BI, possibly requiring surprise tactics to manage market expectations effectively. With upside risks to inflation from imported inflation and energy prices, BI’s policy decisions in the coming months will be closely watched by both domestic and international investors.

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