The Indonesian currency, the rupiah, is now approaching the critical level of 18,000 against the United States (US) dollar, thus triggering action by Bank Indonesia (BI) that will increase efforts to stabilize the currency.
The rupiah was reported to be 0.3% below the 18,000 level after recording a new fall on Wednesday.
Several financial institutions including BNP Paribas, MUFG Bank and Mega Capital Sekuritas expect the central bank to strengthen intervention measures in the market in addition to considering an interest rate hike as early as this month.
According to BNP Paribas analyst, Parisha Saimbi, the 18,000 level is seen as a level that needs to be closely watched by the market because it has a large psychological impact on investor sentiment.
“Bank Indonesia is expected to continue to try to slow the rate of depreciation of the rupiah through various intervention measures,” he said.
So far this year, the rupiah has been the weakest-performing currency in Asia. The situation is being driven by rising global oil prices, which are increasing the cost of government subsidies, raising concerns about the country's fiscal position.
Analysts have also warned that if the rupiah hits 18,000 against the US dollar, it could accelerate foreign capital outflows from Indonesia's stock and bond markets. The situation could add pressure to the government's efforts to boost investor confidence.
Sentiment towards Indonesian assets has also been hit by a series of negative developments since the start of the year. These include warnings that Indonesia's stock market could be reclassified as a frontier market, a review of the country's credit outlook by rating agencies and concerns about government policies that are seen as tightening controls on key commodity exports.
Meanwhile, Indonesia's main stock index fell to a five-year low on Wednesday, in line with the rupiah's weakness and concerns about a possible credit rating downgrade.
The latest economic data also showed Indonesia's trade surplus almost disappeared in April as rising oil and gas import costs outpaced export growth. Rising inflationary pressures in May also added to the challenges facing the country's economy.
MUFG foreign exchange strategist Lloyd Chan said rupiah stability is one of Bank Indonesia's key roles.
"Based on current developments, Bank Indonesia is likely to need to raise interest rates again in June," he said, expecting a 50 basis point hike.
Previously, Bank Indonesia has implemented several measures to support the local currency, including issuing rupiah-denominated debt instruments and tightening US dollar purchase conditions. Last month, the central bank also surprised the market by raising interest rates by 50 basis points.
However, efforts to defend the rupiah have also taken a toll on the country's foreign exchange reserves. Indonesia's reserves have reportedly fallen to their lowest level in almost two years, sparking concerns that a continued decline could negatively impact the country's credit rating.
According to Mega Capital macro strategist Lionel Priyadi, Bank Indonesia is expected to continue market interventions although their effectiveness may be limited as fundamental risks to Indonesia's economy are increasing.
He expected the central bank to raise interest rates by between 50 and 75 basis points in the near future to ease pressure on the rupiah and restore investor confidence.
