The currency war has impacted Indonesian financial markets, with the value of the rupiah dropping more than 2 per cent since US-China trade negotiations earlier this month. Photo: AFP
Muhammad Zulfikar Rakhmat and Dendy Indramawan
Muhammad Zulfikar Rakhmat and Dendy Indramawan

How the US-China currency war will impact Indonesia

  • Beijing’s devaluation of the yuan and Trump’s decision to label China a currency manipulator have seen the trade war escalate to a new level
  • These actions have roiled global markets and the fallout will also reach Jakarta, pressuring the rupiah and widening its trade deficit
The latest round of trade negotiations between Washington and Beijing earlier this month ended badly, with both sides firing a broadside – US President Donald Trump threatened to slap tariffs of 10 per cent on US$300 billion of previously untouched Chinese goods, while Beijing responded by lowering the value of the yuan.
Weakening the Chinese currency to seven to the dollar, its lowest level in 11 years, knocked down financial markets and global commodities. Trump responded in kind by labelling Beijing a currency manipulator, meaning the trade war has now become a currency war.
In his state of the union speech on August 16, Indonesian President Joko Widodo said the country had to be aware of the challenges arising from the US-China trade war.

“We also need to be alert regarding the currency depreciation done by some countries, such as China’s yuan and Argentina’s peso,” he said.

The advent of the currency war has impacted Indonesian financial markets, with the value of the rupiah dropping more than 2 per cent since the trade negotiations earlier this month. Other regional currencies have been impacted too.

While Indonesia’s economy suffered during the 1997 Asian financial crisis, this time it was strong enough to bear the brunt of the yuan’s devaluation, weakening only 2 per cent.

The country’s economic foundation is also stronger – its foreign exchange reserves in the first half of this year reached US$123.8 billion, equivalent to 7.1 months of imports and above the three-month reserve limit usually adhered to by central banks around the world.

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Indonesia’s government and central bank also succeeded in maintaining inflation at 3 per cent between 2016 and this year, the lowest rate since the aftermath of the financial crisis. Economic growth has been maintained at a stable 5 per cent in the midst of economic uncertainty, despite the fact that this level is not enough for Indonesia to quickly escape from the middle-income trap.

However, the fall in the rupiah caused by the devaluation of the yuan has drawbacks for the Indonesian economy in the long term, due to the strong reliance of domestic manufacturers on imported materials.

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Based on data from the Indonesian Statistics Agency, three quarters of total imports are basic and auxiliary materials. The rupiah’s depreciation will certainly see an increase in the price of foreign goods. As a consequence, the prices of finished goods in Indonesia will go up, causing the inflation rate to rise in tandem.

Josua Pardede, economist at Indonesian lender Bank Permata, said the devaluation of the yuan increased investment risk, so market participants would look for the safest assets to invest their capital. Therefore, risk aversion is a strong sentiment in the market.

Based on historical data, the weakening of the yuan will also drag down the value of other currencies, especially those of developing nations. “China’s efforts to weaken its currency are seen by investors as a retaliation in the trade war,” Pardede said.

President Joko Widodo says Indonesia needs to be alert regarding other countries’ currency depreciation activities. Photo: AP

A weaker yuan will also make it difficult to stop imports of Chinese goods, which will be the same or even cheaper if measured in US dollars. This will see goods such as raw materials and manufactured products like cars easily flooding the Indonesian market. This is an ingenious policy as in many countries prices of Chinese goods will be more competitive against the might of the greenback.

The situation is made worse by the fact that since the trade war began, Indonesia’s imports of Chinese goods have increased. According to the Ministry of Trade, the trade deficit between Indonesia and China declined from US$14.3 billion in 2015 to US$12.6 billion in 2017 – only to jump 50 per cent to US$18.4 billion last year. This year, the deficit seems to be growing wider, as it increased 8.7 per cent in the first half of the year.

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Export-oriented products from Indonesia will find it increasingly difficult to compete with products from China and other exporting countries. At a macro level, if Indonesia’s products fail to compete, the result will be a decline in its exports.

All of these mean that Indonesia’s trade deficit with China will grow higher, particularly because the country does not have a strong downstream manufacturing industry. It is also definitely a target for market penetration because it is the largest domestic market in Southeast Asia, with a rapid growth in the population of the middle class, which tends to be consumptive.
An employee counts US dollars at a money changer in Jakarta. Photo: EPA

In addition, the flow of funds looks likely to turn around and pressure the rupiah and the Jakarta Composite Index because market participants prefer safe havens. Foreign investors are looking to sell Indonesian stocks, which could make the index plummet. This month, the index has shown a downward trend after being bullish since May and had reached a peak around the 6,450 mark last month.

Besides increased imports and trade deficits, the situation will also affect Widodo’s plans to shore up growth, which include several measures to tighten imports in favour of domestic production.

Indonesia does not have much ammunition to participate in this war. Its options include staying domestically focused and looking for import substitutions, while slowly building an export-oriented manufacturing base.

An equally important step that Indonesia can take as the trade war transforms into a currency war is increasing its foreign direct investment. This can help offset its current account deficit, which is growing due to the trade deficit.

Muhammad Zulfikar Rakhmat is a lecturer at the Islamic University of Indonesia and research associate at the Institute for Development of Economics and Finance in Jakarta.