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Weak rupiah eating away at Indonesia's domestic demand

JAKARTA -- Indonesia's domestic demand should be chugging along, but a weakening rupiah and rising inflation are crimping spending by consumers and businesses alike.

Inflation blues

In predominantly Muslim countries like Indonesia, the busiest shopping season occurs during the Islamic holy month of Ramadan. This year's Festival Jakarta Great Sale, an annual sales event that runs for roughly five weeks during this time of the year, involved no less than 78 malls, multiple shopping centers and thousands of shops across the capital, attracting bargain hunters from Indonesia and abroad.

     But business has not been as brisk at this year's Great Sale, which kicked off on June 6. "Sales in the first half of the event declined by as much as 25% from a year ago," said Ellen Hidayat, head of the FJGS 2015 committee and chairwoman of Indonesia Shopping Centers Management Association.

     Total sales rose a disappointing 7% on the year, marking the first time the event has failed to achieve double-digit growth since assuming its current form in 2009. This anemic increase came despite having the largest number of participating shops and extending late-night operations beyond opening weekend.

     Hidayat attributed this to the continued surge in the consumer price index, which stood at 7.26% in June. "Many shoppers are choosing to buy affordable goods closer to home instead of going on a shopping expedition."

     The capital is not the only place experiencing weaker sales. According to the Indonesian Hotel and Restaurant Association, sales at shopping malls, including restaurants, across the nation declined 20-30% on the year during the first half of 2015.

     Rising inflation is putting consumers increasingly on edge. Bank Indonesia, the nation's central bank, reported that the consumer confidence index in June dropped 1.5 percentage points from the previous month to 111.3 points. This is slightly above the 100 mark -- the line used to determine whether consumers are optimistic or pessimistic -- but it is nonetheless rare for the figure to dip during the festive Ramadan shopping season. The CCI during this time last year, for example, hit a roughly two-year high.

Running out of gas

The darkening mood is even more noticeable in smaller outlying cities, particularly those with moderate-sized populations. The CCI in Palembang, a city of 1.45 million on the island of Sumatra, slid 20.6 percentage points, while that of Banjarmasin on the island of Kalimantan, with its population of 620,000, dropped 13.7 percentage points.

     Sales of automobiles and motorbikes for the six months through June fell by around 20% on the year. A senior official of a Japanese automobile component maker that has been supplying parts for trucks and motorbikes in Indonesia for more than a decade blamed the slump on the weaker rupiah rather than on a decrease in actual demand.

     The company suspended production lines for two days in June to deal with the softer sales, but it also faces rising production costs, as it sources metal and other materials from abroad.

     "We will definitely log a loss this year and may not be able to continue doing business here if the difficulties continue next year," the official said.

     Indonesia is the largest car and motorbike market in Southeast Asia, but automakers and their suppliers cannot simply pass on costs increases to buyers. Doing so would only further discourage drivers from opening up their wallets.

     The official at the Japanese component maker said that its clients, far from accepting higher prices, have demanded price cuts. As a result, employees' wages have not risen as expected, dealing a further blow to consumption.

Painfully weak

Rising consumer prices and slowing consumption can be traced to the weakening rupiah, which has fallen roughly 40% against the dollar during the last three years. The exchange rate is now hovering around 13,300 rupiah to the greenback, the lowest level since the Asian financial crisis in 1997-1998.

The Indonesian rupiah is trading at its lowest level against the dollar since the Asian financial crisis in 1997-1998.   © Antara

     This continued depreciation has pushed up core inflation, which excludes the volatile prices of raw food and energy, to above 5% for the first time in roughly four years.

     Assuming the U.S. Federal Reserve raises interest rates in September, an executive at a Japanese bank in Jakarta said, the Indonesian currency could weaken to 14,300 rupiah against the greenback between now and then. A U.S. rate hike would draw investors away from rupiah, which is deemed a risky asset.

     The weaker rupiah could also become a liability for Indonesian businesses.

     The nation's private-sector external debt as of April was double what it was a decade ago. Roughly 90% of the loans were made -- and will have to be repaid in -- dollars. An unfavorable exchange rate would make it hard for many domestic-focused Indonesian companies, which generate sales primarily in rupiah, to turn a profit.

      Indomobil Sukses Internasional, an automobile unit of Salim Group, posted a net loss last year. It has formed production and sales alliances with Japan's Nissan Motor and other carmakers to strengthen its position.

      Garuda Indonesia has also reported a loss -- its first since debuting on the market in 2011 -- largely due to the increased cost of purchasing aircraft and fuel. The state-owned flag carrier pays for most of its fleet and fuel dollars.

      Rising interest rates at commercial banks, meanwhile, are discouraging businesses from investing in equipment and facilities due to the higher cost of borrowing.

      Investors started dumping the rupiah in mid-2013, scared off by the country's rising trade deficit. Exports of resources, Indonesia's main export, took a severe hit around that time from the economic slowdown in developed nations and China.

     Growing domestic demand exacerbated the situation, as an increase in imports of consumer and producer goods caused the trade deficit to widen further. In a more industrialized economy, a weaker currency would have helped boost exports. For Indonesia, however, which is yet to develop competitive industrial exports, the benefits of a weaker rupiah are limited.

Government quandary

Jakarta will be hard-pressed to come up with effective solutions, as it is already burdened with a fiscal and current-account deficit.

     Since taking office last October, President Joko Widodo has rolled out a series of reforms aimed at resolving the deficit problem. These include raising the fuel price, increasing the budget allocation for infrastructure development and simplifying procedures for investment.

     Widodo has also pointed to his efforts to improve social welfare through such measures as introducing free medical care and education for the poor, and developing housing for workers.

     But such reforms have borne little fruit. The supplemental budget for fiscal 2015, which began in January, increased the allocation for infrastructure development projects, but only a little over 30% of them had been executed as of July. According to a stakeholder, this is mainly due to the confusion arising from Widodo's reorganization of government agencies.

     Fear of getting caught up in a corruption scandal is also dissuading government officials from placing or receiving orders for construction work and procurement.

     Making matters worse, measures proposed by cabinet members to promote domestic industries have often been seen as protectionist, damaging the market's trust in the government.

     Many cabinet members are under pressure to quickly come up with a reform plan, effective or not. Ali Setiawan, managing director and head of global markets, at HSBC Indonesia, said this is because businesses and investors have yet to feel the benefit of reforms and are growing impatient with the lack of progress in implementing such measures as preferential tax treatment.

     Despite these clouds, however, Jakarta seems optimistic. It recently revised downward its outlook for gross domestic product for 2015, but the adjustment -- from 5.7% to 5.2% -- was smaller than those made by others. The International Monetary Fund, for example, revised its estimate to below 5%.

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