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Indonesia's Widodo defends falling currency in unconventional ways

Jakarta plans measures to curb imports of fuel and construction materials

Indonesian President Joko Widodo is trying to suppress some imports in order to keep foreign currency reserves in the country.    © Reuters

JAKARTA -- Indonesian President Joko Widodo is deploying series of defensive tactics -- some rather unconventional ones -- to prevent the sell-off of the country's currency, the rupiah, in financial markets.

He has already ordered one measure to boost the consumption of locally produced palm-oil biodiesel fuels to push out imported fuels and is reportedly considering cutting back on his signature infrastructure projects to suppress imports of construction materials.

The Indonesian rupiah has been one of the worst-performing currencies in Southeast Asia in 2018, as the U.S. Federal Reserve continues with a series of interest rate hikes. A falling rupiah could translate into higher inflation, something that Widodo does not want as he aims for re-election next year. 

"The country needs dollars," the president stressed to cabinet ministers at a special meeting in late July, dubbed the "Strategy of Policy to Increase Foreign Exchange Reserve." This is reported to be the sixth time that cabinet ministers have met since the beginning of July to discuss the situation of the declining rupiah.

"Imports must be evaluated. Imports for nonstrategic goods should be stopped or reduced," Widodo said at the meeting.

Widodo on Thursday officially announced he would seek a second term as president, and picked an Islamic scholar as his running mate. His main rival, Prabowo Subianto, also declared his candidacy to set the stage for the general election in April. 

One plan Widodo wants to "immediately implement" is expanding the so-called B20 biodiesel program. The government plans to extend this program, which demands subsidized diesel engine vehicles or public service vehicles like railways to use 20% biodiesel blended into regular diesel to boost the consumption of locally produced palm-oil-based biodiesel.

The measure would result in curbing the imports of other kinds of fuel. According to the Cabinet Secretariat, it "can save foreign exchange from fuel imports amounting to $21 million per day."

With Indonesia the world's top producer of palm oil, such a policy brings the added bonus of supporting the more than 17 million employees in the sector -- a potential vote booster come election time.

"The government has mentioned that the use of biodiesel could save up to $4 billion in oil imports, which is around 0.4% of [gross domestic product]. At the margin, this would help the rupiah, all else [being] equal," said Nupur Gupta, an economist at Goldman Sachs based in Singapore.

Indonesia has seen its currency fall as much as 7% against the U.S. dollar this year, as investors have taken funds out of emerging markets and moved them back to the U.S. amid rising interest rates in the world's largest economy. Bank Indonesia, the country's central bank, has had to raise its key interest rate three times since the start of May to tackle the outflow of funds, as well as intervene regularly in the currency market.

But after a 100 basis points rate rise and a 9% depletion in foreign reserves over the first half of this year, the rupiah is still trading near its lowest level in three years against the dollar, at around 14,500 rupiah.

As things stand, further rate hikes by the central bank have the potential to damage the economy, as banks have started talking about the need to increase their lending rates to adjust for the central bank rate increases.

Noticing the limitations of conventional measures, Widodo is getting creative.

Indonesia runs a persistent current-account deficit -- the central bank estimates it will widen by $8 billion this year to $25 billion -- which has constantly weighed on the rupiah. Widodo believes that by skewing the country's trade balance more to the surplus, he can change the country's economic fundamentals and support the rupiah.

Another plan being touted is the increase in the use of local capital goods in infrastructure projects. That Indonesia's current-account deficit has widened is partly attributable to the increase in imports of infrastructure project related capital goods, and the Indonesian government wants to substitute that with locally manufactured goods. "Keep supporting the growth of import substitution industry," the president has told cabinet ministers.

There have even been reports that he is contemplating cutting back on infrastructure projects to curb imports of goods produced overseas. While there has been no confirmation of such a shift, a recently released list of infrastructure projects that the government is prioritizing included 227 projects, down from 248 a year earlier.

But, to Rohit Garg, Emerging Asia FI/FX strategist at Bank of America Merrill Lynch in Singapore, these measures are "not the most important thing" for Indonesia. "The Indonesian rupiah is currently facing deprecation pressures mainly due to the external environment which is higher U.S. dollar rates, strong U.S. dollar and a weaker Chinese yuan," he said. "There are definitely attempts by the Indonesian policymakers to keep a lid on its current-account deficit... At the moment, the evolution of such external factors is more important."

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