In August 2013, three months after the U.S. Federal Reserve triggered a sharp sell-off in emerging market assets by announcing plans to scale back its quantitative easing program, Morgan Stanley issued a research note in which it singled out several countries it believed were most at risk from the fallout from a tightening in U.S. monetary policy.
The bank's "Fragile Five" list is made up of South Africa, Brazil, Turkey, Indonesia and India. The two Asian countries were, at the time, the focal point of investor nervousness about developing economies because of the dramatic declines in their currencies and concerns about the credibility of their policymakers.
Nearly two years on, it is Brazil and Turkey that are deemed more vulnerable, mainly because of their failure to attend to underlying economic weaknesses.
India and Indonesia are no longer considered members of the Fragile Five. Yet, while market conditions in India remain extremely buoyant, sentiment toward Indonesia is more fragile.
The question is whether it is sufficiently fragile for it to be readmitted to the ill-famed club.
There are a number of worrying signs.
The Indonesian rupiah has fallen 12% against the dollar since May 1 last year. While the benchmark Jakarta Composite Index hit a record high in early April, Indonesian equities are barely in positive territory this year in dollar terms, compared with strong gains in other emerging markets such as China and India. Foreign exchange reserves are the lowest in Southeast Asia as a share of gross domestic product, and the current-account deficit amounts to 3% of GDP.
The stakes for Indonesia are high given that the country is reliant on foreign portfolio inflows to finance its current-account shortfall, which is more than twice the size of India's as a proportion of GDP. Foreign holding of the country's government debt, at 38%, is also one of the highest among the main emerging markets.
The sharp fall in the rupiah, although helping strengthen external competitiveness, is focusing attention on two troubling aspects about Indonesia: the direction of its monetary policy and the political skills of Joko Widodo. The latter is a key consideration, given the structural and institutional reforms Indonesia's new president seeks to implement.
On Feb. 17, Indonesia's central bank unexpectedly -- and almost certainly prematurely -- cut its benchmark rate by 25 basis points to 7.5%. The rate cut suggests that the central bank is more concerned about boosting growth than curbing the current-account deficit, thereby increasing Indonesia's vulnerability to a rise in U.S. interest rates.
More worryingly, Widodo has stumbled.
On Feb. 18, he was forced to withdraw his nomination of an allegedly corrupt official for police chief and suspend the head of Indonesia's anti-graft agency, tarnishing his image as an anti-corruption campaigner.
Laying the groundwork
Still, Widodo has already undertaken some crucial reforms since assuming the presidency in October. In late December, his administration capitalized on the plunge in oil prices by scrapping $18 billion of fuel subsidies in one of the most important fiscal reforms undertaken by an emerging-market government in recent years.
This has allowed Indonesia to free up funds for much-needed investment in infrastructure. According to Bank of America Merrill Lynch, capital expenditures will exceed energy subsidies for the first time in a decade, with the former increasing 75% this year to some $23 billion.
Widodo has, in the space of just several months, laid the groundwork for a major shift in Indonesian fiscal and economic policy that prioritizes investment, which grew by a paltry 4% last year. In February, the government's infrastructure-focused budget received strong parliamentary backing in a sign that Widodo's ruling coalition, despite controlling less than half the seats in parliament, is able to push through reforms.
The central bank, moreover, gave itself some breathing room when it hiked interest rates aggressively in the months following the Fed's decision to wind down, or "taper," its asset purchases.
Make no mistake about it, Indonesia is reforming under Widodo -- and making significantly more progress than Brazil, to say nothing about Turkey.
While sentiment toward Indonesia may not be as buoyant as it is toward India, it is by no means bleak. In the country's high-yielding domestic bond market, foreigners have increased their holdings by 32% since the end of 2013, compared with a reduction of 8% in Turkey, according to Bank of America Merrill Lynch.
For the time being, Indonesia is not at risk of being readmitted to the "fragile" club of emerging markets.
Nicholas Spiro is the founder and managing director of Spiro Sovereign Strategy, a London-based consulting company that specializes in sovereign credit risk.