Indonesia’s trust crisis sinks the rupiah

Ko Young-kyung

The author is a research professor at Yonsei University’s Digital Trade Research Center and the director of Asia Biz Lab

The weakness of Indonesia’s rupiah is becoming increasingly difficult to ignore. Since the start of this year, the currency has fallen about 9 percent against the U.S. dollar, reaching a record low. Indonesia’s central bank raised interest rates by 0.5 percentage points in May, but the currency continued to weaken. On Tuesday, it held an emergency meeting and delivered an additional 0.25 percentage-point hike, the first unscheduled increase in eight years.

Korea is also facing pressure from a weaker currency, but market sentiment is different. Strong economic fundamentals, including record exports, have helped sustain confidence in the won.

Although the energy shock stemming from the Middle East conflict has weighed on Asian economies, it does not fully explain Indonesia’s difficulties. The turning point came on May 20, when President Prabowo Subianto announced plans for stronger state control over natural resources.

Under the proposal, exports of palm oil, coal and processed nickel products such as ferronickel would be handled exclusively through a designated state-owned enterprise. The government would also play a direct role in setting prices for key resources. Prabowo even suggested that resources should remain underground rather than be sold below what he considers fair value.

The government further ordered that all foreign-currency earnings from resource exports be deposited in state-owned banks for one year and cut by half the amount exporters can convert into rupiah.

The measures unnerved foreign investors. Indonesia’s stock market has fallen more than 34 percent this year. Foreign ownership of Indonesian government bonds, once close to 40 percent, has dropped to around 13 percent. The Chinese Chamber of Commerce publicly expressed concerns on behalf of Chinese firms, which have invested heavily in Indonesia’s nickel mining and smelting sectors.

Prabowo’s actions reflect a long-standing belief in resource and economic nationalism. Despite more than two decades of trade surpluses and economic growth, he argues that a shrinking middle class and rising poverty are the result of a flawed economic system and the outflow of national wealth. He has cited underreported export prices, transfer pricing, smuggling and capital flight as major causes.

Interest-rate hikes and export restrictions may provide temporary relief, but they are not long-term solutions. Moody’s and Fitch have maintained Indonesia’s investment-grade ratings while lowering their outlooks to negative. MSCI has also warned that Indonesia could be downgraded from an emerging market to a frontier market.

Indonesia is not in crisis when judged by debt levels or foreign-exchange reserves. Its growth potential remains substantial. The problem is not the numbers. It is trust. And the market appears to be rapidly losing confidence in Prabowo.