Forex Investment and Currency Trading

Appreciation of the IDR against the USD in Q1 was in line with the positive view on the currency. Looking ahead, IDR is continued to forecast gains to 9000 by end-2008 (versus the forward 9705), anchored by a balance of payments surplus and a manageable fiscal deficit, despite high oil prices. Bank Indonesia policy bias is IDR supportive as it remains cautious on the inflation outlook. Risk to this view is further volatility in global credit markets to which Indonesia is vulnerable due to the high foreign ownership of government bonds.

The current account remains in a surplus, with exports of non-oil and gas commodities continuing to offset rising net oil imports. Short-term capital flows have also been resilient: as of February net foreign buying of government bonds and stocks has remained positive. A dramatic reversal of these flows is unlikely given wide interest rate differentials versus the US and still encouraging growth prospects.

The government has raised its budget allocation for fuel subsidies due to high oil prices. As a result, the overall fiscal deficit is now expected to rise to 2.1% of GDP from 1.7% in the original budget. However, this remains manageable, and demonstrates that the government is better prepared to contain the budget strain from rising oil prices without resorting to outright subsidy removal. The increase in the subsidy is being partly offset by other sources of revenues including higher dividends from state enterprises and better tax collection.

Any changes to the policy rate is not anticipated over the next few MPC meetings. The bias, however, is increasingly tilted towards a hike given that inflation is now running well above the 4-6% BI target. But recent rhetoric by BI officials suggest that the central bank will not deliver a hike just yet, acknowledging that pressures to inflation are mostly supply-driven. As such, BI may support a strong IDR to ward off imported inflation. FX reserves remain high at USD56bn, providing the wherewithal to intervene in the face of bouts of IDR weakness.