Try the CSQ on your own. But for the following 2 questions, please post your comments as a group (leader - please co-ordinate)
3(a) Evaluate the possible impact of rising oil prices on the Indonesian economy. (8)
- Since the question is asked with regards to the Indonesian economy at large, one way of structuring your answer is via the 4 macro goals.
- Review the case evidence to ascertain if Indonesia is a net exporter or net importer of oil. That will be important for your analysis.
- Try to support your points with evidence from the case as far as possible. For this question, Table 1 will be particularly helpful.
4. Assess how the measures taken by the Indonesian government will affect the rupiah. (8)
- Identify the measures from the case.
- An assessment would require you to explain how each measure impacts the currency as well as the extent of the impact.
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With the increase in oil prices on the Indonesian economy, it will have a negative impact on Indonesia’s economy on the whole. The four main macro economic goals would be positive economic growth, low levels of inflation, low unemployment rates and a surplus in Balance of payments (BOP).
ReplyDeleteWith the increase in oil prices in Indonesia, and it moving towards becoming a “net oil importer” this year as mentioned in Extract 2 due to the fact that “ Indonesia has failed since early 2002 to meet its output quota” and it may turn to import “ a net 61000 barrels aday from net exports of 27000 barrels a day in 2004”, this would then account for the drop in it’s current account balance as seen in table 1, from US$69000million in 2002 to US$1564million in 2005, due to the fact that Indonesia is moving towards importing oil instead of exporting them. This then in turn creats a burden on the government to “subsidize fuel costs for 238.5 million people”, as mentioned in Extract one, thus also accounting for the negative government budget in 2005 which would be -24417billion Rupiah. All this would then lead to a deficit in Indonesia’s Balance of Payment.
Another possible impact would be since there is now a “soaring demand” for oil due to China’s rise as a major global economy as mentioned in Extract 2. Since Indonesia is MOVING towards becoming a “net oil importer” but not yet BEING one, it still exports oil, but at a minimal rate. Thus an increase in Demand for Indonesia’s oil would then cause an increase in demand for Rupiah as the countries like China would need Rupiah to pay for their exports. This would then cause the Rupiah to appreciate, in turn causing the prices of commodities and locally-produced goods becoming more expensive due to inflation. This would thus cause the demand for Indonesia’s goods to fall due to the fall in purchasing power of the citizens. This lack of demand for the goods would also be doubled due to Asian’s thrift nature. Furthermore, the downward multiplier effect would also cause a downward spiral effect on Indonesia’s already ailing economy.
The next possible impact would be, due to the rising inflation in Indonesia, companies would then have to retrench workers due to the lack of funds to pay salaries to their workers. This is then supported by the figures in table 1, the unemployment rate in 2002 was 9.1% as compared to 2005’s 10.3% this then tells us how much the increase in oil prices in the economy has affected Indonesia’s economy negatively.
With all the reasons stated above, the investors abroad would also not have a positive business outlook with regards to Indonesia’s economy, leading to investments by foreign companies dropping. This is further supported by the negative FDI in table one, in 2004, it’s net FDI investments was “-US-597million” while in 2005, it dropped further to a US-1512million, thus showing us how much investor confidence has plunged due to the bleak future of Indonesia’s economy.
Therefore, the increase in oil prices has lead to a downward spiral on Indonesia’s economy, causing all four goals of Macroeconomics to be unfulfilled, thus needing immediate government intervention to stop the worsening of Indonesia’s economy.
Hi! :) The above question was Q3(a). The following would be question 4:
ReplyDeleteFrom the case study, we have identified two measures which were taken by the Indonesian government. They are - reducing fuel subsidies, and the Central Bank raising its interest rates.
A reduction in fuel subsidies will minimise the drainage on Indonesian government's finances, and will therefore lower the budget deficit, because the govt cuts down on govt expenditure. As such, money supply will decrease, leading to an appreciation in the rupiah. Furthermore, the decrease in money supply will lead to an increase in interest rates, in the hopes of stimulating savings so that banks will be able to credit-create. As such, short-term capital flows may increase, as foreigners wish to deposit their money in Indonesian banks so as to make profits from their relatively higher interest rates. This will cause the Indonesian rupiah to appreciate further, since the demand for rupiah will increase.
In addition, a reduction in fuel subsidies will cause the price of fuel to increase, and may cause a "trim in fuel demand". If fuel consumption decreases significantly, imports of fuel will decrease as well. Hence money supply of rupiah decreases. This will lead to an appreciation of rupiah as well.
The extent of the impact of this measure may not be substantial enough to lead to a decrease in demand for fuel, as demand for fuel is relatively price inelastic due to a lack of close substitutes, unless people choose to take public transport or walk if their destination is fairly near.
Moreover, if the fall in demand for fuel is substantial enough, it will ease inflationary pressure on fuel prices, and lead to a fall in fuel prices. As such, this measure may backfire, as the demand for fuel may increase or revert back to its original level, since the price of fuel is relatively cheaper now.
The other measure taken by the Indonesian government would be the Central Bank raising its interest rates. This increase in interest rates would result in a decrease in investments made in Indonesia. Without new investments, and a domestic production of oil that has failed to keep pace with demand, Indonesia would “probably end up as a net importer of oil”. This would increase the supply of rupiah as trade is affected, and cause it to depreciate. Indonesians would have to buy oil from overseas as their domestic output of oil is not enough to meet their demand. However, the increase in interest rates in Indonesia will reduce short-term capital outflows from Indonesia to other countries, decreasing the supply of the rupiah, causing the rupiah to appreciate.
The extent of the impact of this measure is limited, and from extract 1 it says that the rupiah is still “rapid depreciating”. This means that the measure to raise interest rates has not proven successful to halt to reduce the depreciation of the rupiah. This could be because more investments are being pulled out of the country than the outflows going in. And the reduction in capital outflows from Indonesian due to the increase in interest rates is only a short-term effect and is not sustainable enough to counter the rapid depreciation of the rupiah.
Q3a
ReplyDelete4 Macro Goals
- High and sustained growth ( GDP growth rate)
- Full employment/ low unemployment
- Stable prices or low inflation rate
- Close to BOP eqm.
With the increase in fuel prices, there will be an increase in the supply of Rupiah, causing the currency to depreciate. In order to counter the depreciation and maintain the exchange rate, the government increase the interest rate to raise demand. Based on extract 1, line 5, the Indonesian “central bank raised its benchmark interest rate to 9.5 percent to stem the rupiah decline”. Now with a lower exchange rate, more countries will want to export goods from Indonesia, therefore increasing their export revenue, current account will therefore experience a surplus, as seen from table 1.
Also, with an increase in oil prices, there is an increase in the cost of production, therefore decreasing the demand of goods, causing real GDP to fall. However, with the lower exchange rate, the increase in exports counters this fall, increasing real GDP, as seen in table 1, resulting in better business prospect, probably drawing investors to invest in Indonesia. However, with an increase in interest rate, the cost of borrowing increases, therefore giving investors a higher incentive to save instead of investing. From table 1, Net FDI generally stayed negative therefore indicating that GDP of Indonesia will therefore not experience high and sustained growth. Slow potential growth in the Indonesian economy will result in the economy not being able to expand enough to meet increasing needs.
.Also, the government has “reduce fuel subsidies” causing producers to experience a higher cost of production. With increased costs of production, producers will produce less goods and try to cut down their cost of production, leading to cutting labour costs, therefore leading to unemployment. From table 1 the unemployment rate has increased from 9.1% in 2002 to 10.3 in 2005. Increasing unemployment will mean an increased underutilisation of human resources. If the Indonesian government provides unemployment benefits, it will lead to an increase in government expenditure, leading to more people willing to be unemployed due to the benefits and also, it reduces the efficiency of the labour and hence a decrease in real GDP.
From table 1 we also see that the inflation rate has been fluctuating from 2002 to 2005. As of 2004 to 2005, where the Indonesian government has increased their oil prices, there is an increase in the inflation rate from 6.1% in 2004 to 10.5% in 2005. The sharp increase has got to do with the increase in oil prices, increase in general price level. This therefore disrupts market mechanisms. This will also cause consumers to deter from domestic goods and choose to buy imported goods (due to lower prices), therefore increasing import expenditure. With a decrease in export revenue and increase in import expenditure, it leads to a BOP deficit, as outflows more than inflows. The deficit thus deters the economic growth of the Indonesian economy.
yanlin's group said...
ReplyDelete4. The first measure taken by the Indonesian government is to increase her Interest rate. “The central bank raised its benchmark interest rate to 9.5 percent.” This measure can help to stem the rupiah’s decline. If Indonesian’s interest rate rises relative to other countries, it will attract short-term capital inflows into Indonesia. This is because if people put their money into the Indonesian bank, they can earn more interest. Thus, the demand for rupiah will increase. Foreign investment in this case refers to lending. When bonds are purchased, investors are lending to the firm that issued the bonds. Higher interest rate means the investors will receive higher returns for their investment. Thus, the demand for rupiah will increase. The increase in the demand for rupiah will shift the demand curve to the right and this will cause rupiah to appreciate in value against other countries’ currencies.
However, this measure may not be effective, as before investors direct their capital into Indonesia, they will also look at the exchange rate risks. And as rupiah is still on a decline trend, and people are not sure about whether rupiah can appreciate in the future. Thus, they may refrain from investing their money into Indonesia. Even though, the Indonesian government raises their interest rate, it may still be lower than some other countries, thus, people may not direct their money into Indonesia. Therefore, the demand for rupiah may not increase and the measure may not be effective in appreciating rupiah.
Another measure taken by the Indonesian government is to reduce fuel subsidies.
“Aug 31 the government plans to increase fuel prices “after October” to cut a subsidy bill forecast to reach as much as 138.6 trillion rupiah”. The measure will make rupiah to depreciate. This is because reducing oil subsidies will increase the oil price and therefore the business cost in Indonesia. As a result, investors will think Indonesia as a less attractive place for investment, and there will be an decrease in long-term capital flow into Indonesia. The decrease in the demand for rupiah will shift the demand curve to the left and rupiah will depreciate.
There will be a loss of business confidence in Indonesia. ”but confidence is lacking at this stage because people are not sure whether the fuel price subsidy will be contained”. This will reduce the long-term capital inflow into Indonesia.
3 (a) The rising oil prices occurred in 2005 and during this year, Indonesia was very likely to be a net importer of oil based on the figures prepared for the Energy and Mineral Resources Ministry. In addition, there was 18 % decline in the goods balance in 2005 which might be due to the significant imports expenditure of oil.
ReplyDeleteOil is a raw material for production processes. Being a net importer of oil, rising oil prices would increase the cost of production by firms in Indonesia which would cause an increase in GPL and possibly cost-push inflation. This was further supported by the figures in Table 1 which shows that Indonesia's inflation rate increase from 6.1 % in 2004 to 10.5 % in 2005.
Furthermore, by importing more and pricier oil, Indonesia's current account was likely to worsen, as shown by Table 1, whereby the current account declined by 81 % in 2005. Given the negative FDI in 2005, the capital account was unlikely to be very high either. Therefore, the BOP condition would likely to worsen due to the rising oil prices. This was further supported by the weakening Rupiah in 2005, which might be due to BOP deficit.
Although the possible worsening bilateral trade with Singapore due to rising oil prices might hurt Indonesia's export to Singapore, the positive economic condition in 2005, due to China, India and Brazil's expansive growth, may in fact increased the demand for Indonesia's export. Therefore, although Indonesia's import expenditure rose due to rising oil prices, the net export expenditure might not be that badly affected. Further, the money acquired from Indonesia government's decision to cut oil subsidy might be used to increase government expenditure which might be passed on to customers and this led to the multiplier effect. On a whole, AD might actually rise more than the decrease in AS (due to rising oil prices) which meant positive economic growth, which was supported by Table 1.
Positive economic growth as a combined effect of rising oil prices and other factors, should actually result in a decrease in unemployment rate. However, based on Table 1, the reverse was true. This might be due to the increase in frictional and structural unemployment as negative FDI in 2005 suggests foreign investors leaving Indonesia, people employed in this foreign firms may need to move to another job sector.
4. The strength of Rupiah is affected by the demand and supply of Rupiah as Indonesia, as seen in Table 1, adopt a flexible or managed float exchange rate system. Indonesia's government carry out two measures: decreasing fuel subsidy and increasing interest rate, which will affect the Rupiah.
ReplyDeleteIndonesia is very likely a net importer of oil as suggested by Extract 2 and a declining goods balance in 2005. A decrease in fuel subsidy means the fuel price for Indonesia consumers will be higher. Thus, Indonesia's demand for oil will be lower, and she will import less oil. This means supply of Rupiah will fall. Given that, Indonesia's export is not decreasing (or only decrease a little), at the current exchange rate, demand for Rupiah will be higher than the supply for Rupiah. Thus, Rupiah will appreciate until an equilibrium is reached.
However, this decrease in subsidy is opposed by the rising oil prices in 2005. Being a likely net oil importer in 2005, this rising oil prices will lead to an increase in cost of production and hence GPL will rise. With Indonesia's export becoming more expensive and less competitive, demand for her export is likely to decrease and this will lead to a decline in demand for Rupiah which may negate the effect explained in the previous paragraph.
With the increase in interest rate in Indonesia, foreign investor will be attracted to buy equities and bonds from Indonesia. There will be an increase in the inflow of short term capital flows to Indonesia. At the same time, demand for Rupiah will increase. Given there is no change in the supply for Rupiah, demand for Rupiah will be higher than the supply at the current exchange rate, and Rupiah will appreciate until equilibrium is reached.
This, however, may not be true if other factors are considered. For instance, business confidence may be lacking in Indonesia because investors are worried about the possible social unrest (due to the decrease in fuel subsidy) and the possible cost-push inflation in Indonesia due to rising oil prices. Therefore, foreign investors may not be encouraged to invest in Indonesia. Demand for Rupiah may not rise in fact even though interest rate is increased.
In the long run, reduction in subsidy may have more significant positive effect on Rupiah as compared to the increase in i/r. With less subsidy and thus pricier oil for Indonesia consumer, Indonesia may reduce her demand for imported oil. Also, as Indonesia is trying to attract foreign investors to find new oil sources, Indonesia's oil production may increase and exceed her domestic demand in years to come. By being a net exporter of oil, demand for Rupiah will rise and Rupiah will possibly strengthen (as seen from Table in years before 2005). An increase in i/r, though it may attract more short term capital flows, may not be effective in the long run. If Indonesia remains a net oil importer, rising oil prices will lead to cost-push inflation and other macroeconomic problems such as unemployment. This measure, therefore, cannot be sustained in the long run. Moreover, this investment is mostly liquid, thus it can quickly go out of Indonesia, leading to a rapid decrease in demand for Rupiah when the interest rate is pushed down again.
Stephanie, Robin, Caleb and Huixin:
ReplyDelete3a) Indonesia is mainly an oil-exporting country. However in recent years, Indonesia is finding it increasingly expensive to supply oil and hence may switch to being a major importer of oil. The rising oil prices will impact the 4 sectors of the Indonesian economy- its economic growth, unemployment rate, BOP and inflation rate.
The rising oil prices will impact Indonesia’s economic growth- which constitutes actual growth and potential growth. Oil is a raw material that can be value-added and converted into other useful goods and services. When the prices of oil rise, this means that local and foreign consumption of Indonesia’s oil falls. This also means that export of oil falls, as quoted from Extract 2 that Indonesia has failed since early 2002 to meet its output quota, currently at 1.425 million barrels a day”. Falling C and X means that AD falls. This will cause an economic slowdown in Indonesia. Indonesia’s potential growth is also limited since from Extract 1, “the oil price remains very high and the Indonesian economy can’t cope with it”, Indonesia does not extract the oil for its local use or for foreign trade, it is under-utilising its natural resources and also the labour needed for it. Therefore Indonesia suffers from allocative inefficiency, economy is not operating at a point on the PPC, and this needs to be achieved even before the economy can shift its PPC right, which would then mean potential growth.
As Indonesia is facing an under-utilisation of its labour, it results in a rising unemployment rate as shown in Table 1. There has an increasing unemployment rate of 9.1% in 2002 to 10.3% in 2005. With an increasing unemployment rate, Indonesia’s economy will suffer terribly because many of its citizens who are willing and able to work are not able to get a job and contribute to the economy. On top of that, Indonesia gives out unemployment benefits and this further strains its finances because “the government (is also) subsidising fuel costs for it 238.5 million people”. There is a greater outflow than inflow of money from Indonesia’s money reserves and it is detrimental to its economy.
The balance of payments (BOP) of a country is a statement of all international transactions of a country with the rest of the world over a period of time, usually a year. This also means that the BOP records the international inflows and outflows of a country’s currency. As shown in the above paragraph, Indonesia is facing a situation whereby its outflows are more than its inflows and this indicates a BOP deficit. As large deficits have to be financed, Indonesia’s economic growth will be affected. Indonesia’s current account is also falling due to the fall in exports of its oil resulting from “curbed spending by companies including Exxon Mobil Corp”. With the continual rise of oil prices and looking at how Indonesia is not coping well with this situation, many companies or countries, e.g. Singapore will choose not to import oil from Indonesia and if it continues, Indonesia may have to become an importer instead. The lack of new investments might also cause Indonesia to consider that option. This is detrimental to its BOP because if imports exceed exports, the BOP deficit will worsen and this will hinder Indonesia’s economic growth.
Stephanie, Robin, Caleb and Huixin:
ReplyDeleteThe rising oil prices have impacted the country’s inflation rate. From 2002-2004, inflation rate fell by 5.7%, whereas from 2004 -2005, it rose rapidly by 4.4%. This shows an instable inflation rate, since the rate fell and rose rapidly in just 3 years. This is representative of the unstable prices of goods and services in the country, which thus means an unstable economy. There is cost-push inflation in Indonesia. This may be due to imported inflation, which is the rise in import prices independent of the level of AD, and since Indonesia’s net imports of oil has increased in these times of rising oil prices, from Extract 2, “importing a net 61,000 barrels a day this year from net exports of 24,000 barrels a day in 2004”, it means that Indonesia will be heavily impacted by the rising prices of oil imports. Also, mentioned in Extract 1, Indonesia’s “falling currency”, and the “rupiah fell “5.1 percent in the past month”. Depreciation of Indonesia’s currency means that one unit of Indonesia’s currency can be exchanged for less foreign currency, thus this means that foreign imports will be more expensive. This raises the cost of production, which would be translated to higher prices for consumers, thus resulting in inflation. Demand-pull inflation also contributed to the rising inflation rate. This is seen from Extract 2, that “China’s soaring demand helped t o push prices to a record $58.28 a barrel on April 4”. This increase will result in increased global oil prices, which will negatively impact Indonesia’s inflation rate. However, the inflation rate is kept down in Indonesia because the government has stepped in to intervene, as seen from Extract 2, the “government subsidizes fuel costs for its 238.5 million people”. However, this has put such a strain on the government budget that Indonesia aims to “reduce fuel subsidies” such that in 2005, the inflation rate in the country has risen drastically.
In conclusion, rising oil prices have been detrimental to Indonesia’s economy and have caused all four macroeconomic goals to be unfulfilled in the country. In order to stop the situation from worsening, Indonesia has to come up with strategies and implement them as soon as possible so as to prevent its economy from anymore damages.
The first measure the Indonesian Government had done was to cut fuel subsidies. From extract one, “yudhoyono said August 31, the government plans to increase fuel prices “after October” to cut a subsidy bill forecast to reach as much as 136.6 trillion rupiah”. A reduction in fuel subsidies will cause the price of fuel to increase, and may cause a "trim in fuel demand". This is because, fuel has become more expensive and hence demand for it will decrease. This will decrease the amount of funds needed for the government to subsidise on oil. As a result, imports of fuel will decrease as well. Hence money supply of rupiah decreases. This will lead to an appreciation of rupiah. However, this measure may not be as effective as predicted because oil is price inelastic due to lack of close substitutes. Demand for oil will not fall proportionately to the rise in prices. This policy may thus have a negligible impact on the rupiah.
ReplyDeleteThe second policy is the rise in interest rates. “The central bank raised its benchmark interest rate to 9.5 percent.” In the short run, this will attract an inflow of capital into Indonesia. Foreign investors will be enticed to invest in Indonesia and hence demand for Rupiah will increase. However, the extent of help is limited as Rupiah is still rapidly depreciating. Investments will be pulled out as inflows of capitals is happening. In the long run, where the inflow of capital is not as strong, the rapid decrease in investment will be significant enough to cause a further depreciation of the Rupiah.
By: Sandra, Casandra, Shermaine, Bob -
ReplyDelete3a)
Introduction:
Rising global oil prices affects the overall health of Indonesia’s economy in 4 main ways – decline in its economic growth rate, rise in unemployment levels, worsening domestic inflation, and growing balance of payment (BOP) deficit.
Economic growth rate – the rate of increase in Indonesia’s actual output of goods and services.
Gross Domestic Product (GDP) – total value of Indonesia’s overall output of goods and services it produces.
Inflation – the sustained rise in general price level (GPL)
BOP – the record of Indonesia’s international outflows and inflows of its currency.
The worsening of Indonesia’s domestic inflation:
• Indonesia can be regarded as a net importer of oil, as seen from paragraph 2 of Extract 2, “The country may turn to importing a net 61,000 barrels a day this year from net exports of 27 ,000 barrels a day in 2004”
• Thus it will be affected by rising global oil prices.
Rise in oil prices due to OPEC’s lack of spare production capacity and rising demand by China, as seen in paragraph 6, Extract 2, “Global oil prices have reached records because of limited spare output capacity among OPEC's
members and increased demand from China, whose imports have risen over the past decade from zero to 41 percent of local consumption.”
• Oil is an essential factor input in producing many goods and services. Rise in its price means raising production and transport costs in Indonesia.
• This leads to fall in supply by Indonesia’s suppliers and producers, as prices of goods and services will rise with oil price increase. Indonesia’s GPL rises as such, leading to worsening in inflation levels in the country. Imported inflation has occurred.
A rise in Indonesia’s unemployment rate:
• With Indonesia’s producers cutting supply, production levels, output will fall.
• Local firms now require less labor and workers, thus many will cut jobs.
• Consequent rise in unemployment levels, which will have snowball effect on Indonesia’s economy.
• With rising unemployment, Indonesians’ overall wealth and disposable income falls, consequent fall in consumption expenditure (C).
• Multiplier effect sets in – Indonesians in consumer and retail sector will see fall in demand, revenue, consequent fall in their income, they reduce expenditure, C falls further – Indonesia’s AD falls overall. Unemployment rises during the process.
Decline in Indonesia’s economic growth rate:
• As seen in the rising unemployment levels, Indonesia’s AD will fall.
• Indonesia’s level of production declines.
• Indonesia’s real output level falls, GPL falls (AD-AS diagram)
• Fall in output thus reduces Indonesia’s GDP, thus slowing its rate of economic growth overall.
Indonesia’s growing balance of payment (BOP) deficit:
• Indonesia is net oil importer.
• Imported oil is a price inelastic good, fall in quantity bought by Indonesia is less than proportionate than rise in price.
• Thus rise in oil price brings about rise in Indonesia’s import expenditure (M)
• Indonesia’s exports also now more expensive due to higher costs of production.
• Its exports are now less price-competitive.
• Assuming its exports are price elastic, rise in export prices brings about more than proportionate fall in its quantity demanded by foreigners.
• Export revenue (X) falls.
• Net export revenue (X-M) falls and may become negative, that is, M outweighs X.
• This also means inflow of currency (X) will be less than outflow of its currency (M), thus Indonesia incurs BOP deficit.
• Deficit in its current account (CA) arising since imported goods expenditure is now more than its exports revenue.
• AD falls with decline in (X-M), using AD-AS diagram it is seen that national income will also fall as producers earn less, cut jobs, leading to multiplier effect again.
• Overall fall in Indonesia’s AD, equilibrium national income, rise in unemployment level.
By: Sandra, Casandra, Shermaine, Bob -
ReplyDelete4)Assess how the measures taken by the lndonesian government will affect the rupiah. (8)
ldentify the measures from the case.
Introduction:
Indonesia’s government has tried several ways to halt the decline of the rupiah, including cutting of oil subsidies and raising fuel prices, as well as raising the Central Bank’s interest rates. These measures have been undertaken to allow the rupiah to appreciate in value.
Indonesia reduces fuel subsidies, increase fuel prices:
• Extract 1, paragraph 2, lines 1 and 2: “Indonesian President Susilo Bambang Yudhoyono this week said he would reduce fuel subsidies this year”.
• Oil price rises domestically
• Production cost rises, Indonesian goods now more expensive, foreign substitutes become relatively cheaper.
• Foreign demand for Indonesia’s goods, services and assets drops
• Thus foreign demand for Indonesia’s rupiah falls
• AD-AS diagram, rupiah will appreciate in value against foreign currencies, e.g. US$
• Indonesia’s goods, services and assets now relatively more expensive to foreigners, so foreign quantity of rupiah demanded falls
• Foreign goods, services and assets become relatively cheaper to Indonesians, domestic quantity of rupiah supplied rises
• Equilibrium rupiah exchange rate reached where Qd = Qs of rupiah supplied.
• Overall, the rupiah appreciates in value against US$.
• Extent of impact: Export sector is a large and crucial sector of Indonesia’s economy, with its current account at US$1564M and Goods balance at US$20152M. Hence loss in export price competitiveness will have large impact on its exchange rate, causing significant impact on the rupiah’s appreciation against the dollar.
Indonesia’s Central Bank raised interest rate to 9.5 percent (to stem the rupiah's decline):
• From Extract 1, paragraph 2, lines 2 and 3: “the central bank raised its benchmark interest rate to 9.5 percent to stem the rupiah's decline”.
• Rise in interest rates increases rate of return on investment for investors (MEI rises)
• More incentive for investors to move capital, financial assets into Indonesia for investment
• Increased inflow of capital into Indonesia from foreign firms, countries
• Consequent rise in foreign demand for rupiah
• As explained above, equilibrium rupiah exchange rate reached where Qd = Qs of rupiah supplied
• Overall, the rupiah appreciates in value against US$.
• Extent of impact: However, rising oil prices in the country is likely to dampen foreign investment as this causes a rise in business and production costs, rise in expatriate living costs and thus investors would consider if the rise in rate of investment returns outweighs the rise in business costs in Indonesia following the oil price hike. Thus the raising of interest rate in Indonesia is likely to have only a slight effect on raising the rupiah’s exchange rate.
Conclusion:
• In the long run, foreign investor confidence is likely to rise given the stable political climate in Indonesia, as well as the attractive interest rates offered by its Central Bank. This will result in a rise in FDI in Indonesia in the long run. Thus there will be a rise in inflow of rupiah into the country, as foreign demand for Indonesia’s rupiah rises along with rising investment in the country. Coupled with the decline in foreign demand for Indonesia’s exports, the rupiah is thus likely to appreciate in the long run.