By Rae Wee
SINGAPORE (Reuters) – As Indonesia’s government plays fast and loose with its spending plans, a slow exit of foreign investors is turning into a tide that risks engulfing the relatively stable rupiah and bonds.
Bank Indonesia (BI) holds the key to whether the slump in the country’s stocks turns into a wider, ugly selloff. The central bank meets on Wednesday and is expected to stand pat on rates.
“If BI were to surprise with a cut … that’s going to cause further weakness in the rupiah as investors will be worried that the trade-off is for BI to sacrifice the rupiah and tolerate further weakness in order to shore up growth,” said Khoon Goh, head of Asia research at ANZ.
BI’s decision comes at a time when investors’ confidence in Southeast Asia’s largest economy has been waning, as worries grow about Indonesian President Prabowo Subianto’s massive social spending plans, budget cuts and cancellation of a tax hike.
The proposals have raised concerns about Indonesia’s fiscal health, despite the government maintaining its budget deficit forecast at a modest 2.53% of economic output.
Moreover, high interest rates have eroded business earnings and led to a steep selloff in stocks as foreigners, who hold half of listed stocks, pull out. They have sold $3.85 billion worth of stocks since October to be on course for six straight months of selling, a run last seen in 2017.
Jakarta’s benchmark stock index is down 12% for the year so far, putting it near the bottom of the pack in Asia.
“Indonesia’s fiscal policy shifts are raising a great deal of uncertainty amidst global macro volatility and unattractive local valuations,” said Aninda Mitra, head of Asia macro strategy at BNY Investment Institute.
Also stoking concerns is news that Indonesia is set to pass contentious revisions to a military law this week that will allow armed forces personnel to hold more civilian posts, which investors say could be damaging to the country’s business-friendly environment.
Dealing a one-two punch to sentiment is speculation that finance minister Sri Mulyani Indrawati could be resigning, though she denied those rumours on Tuesday.
Rong Ren Goh, a portfolio manager in the fixed income team at Eastspring Investments, said Mulyani’s future matters a great deal to investors, given her reputation for fiscal discipline that sharply contrasts with Prabowo’s approach.
“It’s no surprise that the rumours triggered such a market reaction, given that they have been teetering on an unstable equilibrium for months.”
Spreads on five-year Indonesian credit default swaps (CDS), which measure the risk of a bond issuer not paying its creditors, hit 86 bps on Tuesday based on S&P Global Market Intelligence data, marking their highest for the year thus far.
The selloff in Indonesia’s currency and bonds has been more muted, helped in part by the attractiveness of the 7%-plus yields on the bond.
The rupiah has so far fallen less than 2% for the year, while the yield on the 10-year Indonesian government bond (IndoGB) is up just about 60 basis points from its September low, before Prabowo took office.
But this “carry trade” could unwind swiftly, resulting in a vicious selloff loop between the rupiah and bonds, as has been the case in past episodes of market turmoil. For instance, when the coronavirus first spread to Indonesia in March 2020, the 10-year IndoGB yield climbed nearly 180 bps in less than three weeks.
That raises the stakes for BI’s rate decision later on Wednesday as investors assess how far the central bank, which has a heavy currency stability mandate, will prioritise economic growth over supporting the rupiah via higher rates.
“Intuitively, the rupiah could be under some pressure, but if BI elects to cut, they will probably be ready to smoothen any FX volatility,” said Eastspring’s Goh, who is neutral on the bonds and “positioned defensively” on the rupiah too.
Traders say BI has been intervening heavily to stem the currency’s losses.
The volatility comes at a nervous time for global markets as U.S. President Donald Trump’s tariffs on trading partners raise risks of a broader economic downturn.
“So it’s just a combination of a perfect storm, which is resulting in foreign investors taking a very cautious view of Indonesian assets,” said ANZ’s Goh.
(Reporting by Rae Wee; Additional reporting by Ankur Banerjee and Tom Westbrook in Singapore; Editing by Vidya Ranganathan and Shri Navaratnam)
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