IDR: Rupiah To Range Trade Over H223

Key View

• We expect the Indonesian rupiah to continue trading sideways and to end 2023 at IDR15,300 per USD, from current spot levels of IDR15,246 per USD.
• In the short term, we have turned neutral, from slightly bearish previously, given a neutral technical picture and relatively balanced fundamentals.
• In the long term, we think the rupiah will face downside pressure and maintain our forecast for the rupiah to average IDR15,700 per USD in 2024. Slight weakness will be driven by election risk, slowing global growth and weakness in the external sector.
• Risks to our forecasts are tilted to the downside, as there could be further interest rate hikes in the US and the US could enter into deeper recession than we currently forecast.

Short-Term Outlook

In our last currency forecast we held a slightly bearish view on the Indonesian rupiah, but have turned more neutral largely due to neutral technicals and relatively balanced fundamentals. While the rupiah remains the region’s outperformer, appreciating by +1.1% against the greenback on a year-to-date basis (see chart below, right), the currency has come under pressure, falling -2.0% since May 2023 (see chart below, left). From a technical perspective, we think that the unit will trade broadly sideways between support which comes in around the IDR15,460/USD level and 22-month trendline resistance which comes in at IDR14,800/USD. Looking forward, we continue to expect the rupiah to average IDR15,300/USD for 2023, about 3.0% weaker compared to the 2022 average of 14,850. However, we have revised our forecast for the rupiah to end the year slightly stronger at IDR15,300/USD, from IDR15,600/USD, previously.

In addition to the technical view, our neutral view is guided by fairly balanced fundamentals. Indeed, relatively resilient growth, a pick up in investment flows and the end of the Fed’s tightening cycle will provide support to the rupiah. Real GDP growth came in at 5.2% in Q223, which was above consensus expectations of 4.9%, and the surprise reading led us to revise our full year growth forecast upwards from 4.8% to 5.0%. While our new forecast is still below the government’s projection of 5.3%, it is strong relative to regional peers and global growth (which we forecast at 2.4%). In addition, debt inflows to Indonesia appear to be returning, with cumulative debt flows into the economy comparable to levels seen in 2019 and totaling USD5bn in the first six months of the year (see chart below).

Moreover, we think that Fed’s hiking cycle is over, which should more broadly relieve pressure on emerging market currencies. We expect Bank Indonesia and the Fed to remain on hold for the rest of the year, which implies that the narrowing of interest rate differentials between the two economies has ended (see chart below). In turn, this could be a positive for carry trade and provide support to the rupiah. 

However, several factors will weigh on the rupiah, helping to offset some of the positive dynamics mentioned above. These include increased political risk, and a slightly weaker external sector. The upcoming presidential elections due in February 2024 will add some political uncertainty to the economic outlook. And while the odds have begun to tilt in favour of Prabowo Subianto, who is considered a moderate and has secured the backing of nearly half of the parliament, investors could start to take a ‘wait-and-see’ approach to Indonesia ahead of the vote. In addition, Indonesia’s external sector looks set to remain weak. Exports have continued to decline from their peak of USD28bn in June 2022 and have fallen by an average 12.5% y-o-y in the first half of the year. Moreover, the current account flipped into a deficit of USD1.9bn in Q2 from +USD3.0bn in Q1, dragged down by primary income outflows even as the goods balance remained healthy at USD10.4bn (see chart below). Going forward we believe the current account will post a full-year deficit of -0.1% of GDP in 2023, which is slightly below the Bloomberg consensus of 0.0%. That said, the recent requirement for companies exporting natural resources to keep a minimum of 30% of their FX earnings onshore for at least three months could help to reduce the primary income deficit, but this requirement also has the potential to sour investor sentiment on the economy.

Long-Term Outlook (Six-To-24 Months)

Over the next year, we expect the rupiah will face downside pressure and average at IDR15,700/USD for 2024 and would imply a depreciation of -2.6% from the average of IDR15,300/USD in 2023. Our slightly pessimistic view is due to greater political uncertainty in view of the upcoming elections in February 2024, a slowdown in the global economy and a continued widening of Indonesia’s current account deficit. Indeed, we forecast global growth in 2024 to continue slowing to 2.2%, down from 2.4% in 2023, which will weigh on Indonesia's external sector slightly. We forecast Indonesia’s current account deficit to widen from -0.1% of GDP in 2023 to -1.1% of GDP in 2024 as exports underperform on the back of slower growth and lower commodity prices (see chart below).

Nonetheless, we do not expect excessive downside pressure on the rupiah given that Indonesian growth will remain strong compared to peers and we do not expect BI to cut interest rates until H124. In terms of growth, we forecast the economy to expand by a still-strong 5.0% in 2024, which is well above the 0.5% in the US and the 2.2% for the global economy (see chart below, left). Moreover, we only expect Bank Indonesia to start cutting interest rates only in H124, alongside other major central banks in the world. This will help maintain the interest rate differentials between Indonesia and the US, which should provide support to the currency. At the same time, minimal inflation differentials relative to the US (see chart below, right) should also prevent any substantial downside on the currency as well due to a loss of export competitiveness. 

Finally, we think weakness in the rupiah will be limited because the currency is not particularly overvalued. From a real effective exchange rate (REER) perspective, the rupiah is only trading at +3.0% above the 10-year moving average, which suggests that it is close to being fairly valued. In addition, Indonesia’s import cover stands at 6.0 months, which is well above the three-month minimum recommended by the IMF (see chart below, right).

Risks to Outlook

The risks to our forecasts are tilted to the downside given the potential for a more-hawkish-than-expected Fed. Further hikes by the US would lead to a further narrowing of interest rate differentials which would weigh on emerging markets and the rupiah. Moreover, the US economy could enter into a deeper-than-expected recession in 2024 which would likely result in a sharp decline in global risk appetite and add pressure to the rupiah. Finally, recent stimulus by Beijing to prop up the Mainland economy has had little impact to boost investor, business and consumer sentiment. As such, continued disappointment in the Chinese economy could also weigh further on Indonesia’s external sector via weaker exports.